UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 824-iii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

DEFENCE COMMITTEE

 

 

DEFENCE INDUSTRIAL STRATEGY

 

 

Tuesday 28 February 2006

SIR JOHN CHISHOLM

SIR JOHN ROSE, DR SALLY HOWES and MR MIKE TURNER CBE

LORD DRAYSON, MR DAVID GOULD CB and MR MARK GIBSON CB

Evidence heard in Public Questions 184 - 316

 

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Oral Evidence

Taken before the Defence Committee

on Tuesday 28 February 2006

Members present

Mr James Arbuthnot, in the Chair

Mr David S Borrow

Mr David Crausby

Mr Mike Hancock

Mr Dai Havard

Robert Key

John Smith

________________

Memorandum submitted by QinetiQ

 

Examination of Witness

 

Witness: Sir John Chisholm, Executive Chairman, QinetiQ, gave evidence.

Q184 Chairman: Good morning and welcome to everybody on this inquiry into the Defence Industrial Strategy, particularly John Chisholm from QinetiQ. Sir John, perhaps I could begin by thanking you for coming to give evidence about the Defence Industrial Strategy. I wonder if I could open up our inquiry this morning by thanking you particularly for your memorandum on the Defence Industrial Strategy and read out a couple of bits of that. It says in your memorandum, "The Committee should consider this apparent internal contradiction in a document that speaks so strongly to the importance of technology and innovation on almost every page, yet is silent on the level of defence research funding." I am not trying to put words in your mouth, but I think you are pleased with the recognition of the importance of research and all that that implies within the Defence Industrial Strategy. Do I detect a degree of disappointment with what is actually said about it in the White Paper?

Sir John Chisholm: Good morning, Chairman. Yes, I think you have seized the substance of our evidence. The first point is that we are pleased with the overall thrust of the Defence Industrial Strategy. I think Lord Drayson has done an excellent job in a short period of time to grab a hold of the whole issue of procurement in the United Kingdom and to devise the main themes of a strategy as to how to improve procurement and also improve the industrial base which underpins procurement. We have counted that there are some 600 mentions in the DIS to the words "research, technology and innovation" and that underpins what you have already said, that clearly research and technology appear to us to be well represented as key to a Defence Industrial Strategy. Having said that, there is not a carry through in this version of the DIS as to what the consequences might be in terms of the provision for research and technology in the future.

Q185 Chairman: What do you think it should have said about that?

Sir John Chisholm: We would argue that the logic of the DIS is that research and technology expenditure should be increased to something closer to what it used to be. The paper says that research and technology is important in creating the quality of equipment that the Armed Forces eventually buy; that is clearly implied in the work that underpins the DIS. If that is the case, the equipment that we are buying today reflects the amount that was put in to research and technology in years gone by. If the amount that is now being spent on research and technology is less than what was spent 15 years ago then the implication is that eventually we will suffer from a lower quality of defence equipment than we currently buy. If we actually want the same quality of equipment as we now have then the logical conclusion would be that we should increase the amount currently being spent on research and technology.

Q186 Chairman: On page 39 it says, "A recent MoD sponsored study analysing 11 major defence capable nations has uncovered a highly significant correlation between equipment capability and R&T investment in the last five to 30 years."

Sir John Chisholm: Indeed so.

Q187 Chairman: So more should have been said, you would suggest, in the Defence Industrial Strategy about the way that that R&T was going to be encouraged.

Sir John Chisholm: I do not think I am able to say that more should have been said. I would say that more can be said on that subject.

Q188 Chairman: On page 142 of the Defence Industrial Strategy the words appear "specifically, we will review the alignment of our research programme with MoD needs, conduct further work better to understand the underpinning technologies, update our defence technology strategy, develop a better understanding of the innovation process ..." In other words, there is a lot of work still to be done.

Sir John Chisholm: That is how I understand it. As I understand it, this paper says that this is an area which is incomplete in the DIS and more work is now going to be done in order to fill out that gap.

Q189 Chairman: The way you put it suggests that QinetiQ is not involved in this work or has not been asked to be involved in this work. Is that right?

Sir John Chisholm: The work that needs to be done is obviously government work and QinetiQ, as the other contractors, will eagerly participate in any way they can in helping the government proceed with its strategy.

Q190 Chairman: Have you been asked to be involved in that work yet?

Sir John Chisholm: There is every indication that we will be involved in that work, yes.

Q191 Chairman: What do you think you would be likely to do in relation to that work? What would you like to do in relation to that work?

Sir John Chisholm: We can certainly assist, as we have been doing in the past, in helping the Ministry of Defence decide what the areas of significant priority are. It is, however, for the Ministry of Defence to decide exactly how much money it is appropriate to spend on research and technology. The evidence that we can provide would say that the increased expenditure in research and technology will lead to the quality of equipment which the Armed Forces require in future years.

Q192 Mr Crausby: You argue that there is a strong case for increasing funding for defence research and that was effectively the line that Mr Ferrero took on 7 February when he said, "As I look at the labs today I see a constant reduction in government investment in these technologies and, ultimately, a reduction in the level of innovation that is coming out of the labs." In your memorandum you say that the Defence Industrial Strategy fails to address the implications of the decade long decline in research funding. What are the implications, and what is likely to be the long-term consequences of this obvious reduction in UK defence research investment?

Sir John Chisholm: The obvious consequence of a decline in research expenditure is less resources being available in the labs. Eventually they fall below a critical level and you simply have to stop doing that research. In recent years what we have seen is that the remaining funding has gone as a proportion more to shorter-term research which supports more urgent needs and therefore the larger cutbacks tend to fall upon the longer term, more generic research which is the area from which many of the more profound developments in technology eventually emerge.

Q193 Mr Crausby: I know it is difficult to predict the future without doing the research. Have you got any concrete examples as to how you see that that will put us behind?

Sir John Chisholm: The area which generates new sensor systems, for instance, is an area of technology which in the past has produced important innovations, such as thermal imaging. That is an area where there has been a consistent cutback in the research funds. The consequence of that is one has less resources to investigate very promising future developments. If you do not investigate those you then do not get the breakthroughs and you do not get the equipments which eventually come from that.

Q194 Robert Key: I am very concerned about this level of research spending. As you point out in your memorandum to the Committee, in the Defence Industrial Strategy the government talks about the real terms decline but it does not make any mention of how much defence expenditure should rise by. You assume it will be a drop in real terms though an increase in cash spending but the government does not even say that. Were you very surprised it said nothing about the level of research spending?

Sir John Chisholm: We would certainly argue for an increase in research spending if the objective is at least to ensure the same quality of equipment as we are getting right now in the Armed Forces.

Q195 Robert Key: What do you think is the main driver of research spending by universities? Is it blue skies research, their reputation internationally or are they waiting for signals from government in particular areas that the government would like to see research done in?

Sir John Chisholm: If your question is what is driving university research spending, that is driven largely by the research councils and their process. Their process is heavily driven by the academic quality of research. The research assessment exercise in universities is what drives it. That is driven by citation indices in publication in journals. That is an entirely different mechanism to the mechanism which we are talking about here where the objective of defence research expenditure is superior equipment in the hands of soldiers, sailors and airmen.

Q196 Robert Key: Do you consider yourselves to be in competition with that university-based research?

Sir John Chisholm: Certainly not. It is our role to draw upon the university-based research and make it useful to soldiers, sailors and airmen.

Q197 Robert Key: Is it getting more difficult to recruit and retain the sort of researchers you want?

Sir John Chisholm: It is always difficult to recruit and retain researchers if you do not have the funding to support them. Our business is to win research contracts and conduct them for the Ministry of Defence primarily. If the money is not there for those research contracts we cannot obviously employ the staff.

Q198 Robert Key: Have you given thought to how much money the government should be spending on defence research?

Sir John Chisholm: We have done a calculation and it runs along the lines that if defence expenditure has reduced by 50 per cent in real terms over this period of time and it was that defence expenditure which gave us the equipment today which we feel satisfied with, you might argue that you need to increase defence expenditure back to where it was. We could mitigate that a little by saying that surely we are more efficient now than we were 15 years ago, but an increase of the order of 25 per cent is what we believe would be a sensible policy decision.

Q199 Chairman: Is that an increase of 25 per cent in relation to defence as a whole or in relation to research, technology and innovation?

Sir John Chisholm: Research.

Q200 Mr Havard: What you seem to be saying to me is that within the Defence Industrial Strategy there is going to be another strategy looking at research and technology. That work seems to be not very far forward yet. Do you see that then driving your number or are you going to go in with this bid of increasing by 25 per cent as part of your strategy negotiations for research and technology? It seems to me scientists always argue that the research is better depending on how much money they get. I am not sure that is always true. I understand there is a need for research and technology to be properly funded. Which way round is that going to work? Is it the case that you will go in with a handful of cards saying we want an increase of 25 per cent when the reality of the situation is that what should really happen is that that research and technology sub-strategy within the Defence Industrial Strategy should drive the real decision about what is required? Is that the desire that you think is coming from the Ministry?

Sir John Chisholm: I would certainly accept that the level of research expenditure should be driven by the strategy. So the work that you referred to, which is referred to in the DIS, on the analysis of a research and technology sub-sector, the output of that, I would argue, would appropriately be an increase in research expenditure.

Q201 Mr Hancock: I would be interested if you could explain to the Committee what you think your company's role is in the future bearing in mind what you have said and the past history of the organisation and where it is today.

Sir John Chisholm: The core business of QinetiQ remains the business of technology and innovation in the UK and in the area of defence and security. So we have three main businesses: one is defence and security technology for the UK; secondly, the commercialisation of those technologies into adjacent commercial markets, principally in the UK, and, thirdly, the development of our business in the US based upon those same technologies.

Q202 Mr Hancock: Do you not think you have some responsibility now to invest in the research and development and then sell what you have discovered to the MoD? Smart procurement really demands that the MoD does not pay as much on research and development. Surely it demands that organisations like you have to take the risk on the research and development in the hope that you can then sell a much better product to the Armed Forces for the use of the personnel involved.

Sir John Chisholm: Research the world over has the characteristic that that which is near to market can be invested in by companies and that is the sensible decision for companies to make. Following on from market research, it is much more difficult to see who will get the particular benefit of that research and therefore throughout the world, far from market research as funded by governments, because it is only governments who can take the rational view that benefit will accrue somewhere ---

Q203 Mr Hancock: But this policy states they are going to be less inclined to do that. That is why it is not specific about the values put against it. That is why there is no increase, is it not? This philosophy says the risks should be carried more by organisations like yours in the future who say come to us and we will buy if it is good enough and you can convince us.

Sir John Chisholm: Companies do invest and indeed we invest when we can see a return in the kind of timescale that our own investors are interested in. Where you cannot see a near-term return then that is not a wise investment for a company to make, though it is an entirely wise investment for a country because the country will see the return from that in due course.

Q204 Mr Hancock: One of the arguments for your organisation ending up where it is today, when we had these debates in this Committee some years ago, was that you saw the reality that there would be less and less investment in research coming from government and your organisation, in order to stay as a leader in the field, would have to be able to go out and explore the commercial world more effectively than you had been able to do in the past. You still now want to appear to be saying we will not do too much unless the government is going to front load it. I cannot see how you can have it both ways. You argued the case very effectively for your own organisation at that time that you needed this freedom to go off and do other things. It obviously annoys your colleagues sitting behind because they are pulling faces at what I am saying to you.

Sir John Chisholm: I think the figures I gave you do answer that point. What I said a while ago was that research funding has declined by 50 per cent. I did not go on to argue that it should be recovered by 50 per cent because I said there had been improvements made. One of the improvements made is the freedoms you gave to what were the government labs to go out and modernise themselves and conduct other business. Part of the consequence of that is that we can do more for less than we used to. So there is an absolute gain that the nation has got through the strategy it has adopted.

Q205 Mr Hancock: What do you see as the different roles between an organisation like yours in the future in research and development and what the government would be funding in research specifically targeted towards defence?

Sir John Chisholm: We are a contractor to the government.

Q206 Mr Hancock: What else do you see your company doing in the future which is going to mean your ability to continue to be at the forefront of defence research still being available if you are not going to get the same level of funding from government?

Sir John Chisholm: The point I was making is that we are more efficient than we were before. One of the reasons why we can do more for less for the government is that we are engaged in winning business for our labs not only from the UK Government but also particularly from the United States Government and also from winning business in the commercial sector for that same technology. The funding mix for our laboratories is now more broadly based than it was before and that is a net gain to the UK defence vote because it is getting the benefit of the other funding coming in from other directions and the stimulation of the research work within the labs from that other funding.

Q207 Mr Hancock: How much is your organisation currently spending in funding research and development in small- and medium-size enterprises which are in this field? What proportion of your expenditure on research yourselves are you spending in the outside world?

Sir John Chisholm: I do not have the immediate figure at the top of my head. We spend a considerable amount of the monies that we get from our customers into our supply chain in order to help us do our work. Typically we will farm out a considerable amount of the work that we get into SMEs and into universities in order to capture the best product that is coming from that and in order to assemble that back to what is in the best interests of our customers.

Q208 Mr Hancock: Do you see that in the future as being an increasing trend? On Robert Key's earlier point, would it be a policy that you would adopt that maybe in the future you do not want to employ all these people and it would be far better for you simply to be the prime server and you will sub-contract the research and development elsewhere?

Sir John Chisholm: We certainly see ourselves as forming an important link in the chain between our customers, who want a complete service, who want a complete programme of research or development completed, and a supply base which includes SMEs and universities, all of whom have got a particular niche to offer. So we see ourselves as playing a very important role in that gap between niche suppliers, the universities and SMEs, and our customers who want a complete research solution or technology solution provided to themselves. That is why we are developing university partnerships and SME partnerships which will enable the efficient capturing of those niche capabilities.

Q209 John Smith: In your memorandum you identify a specific failure in the DIS and that is that there is no sustainable policy for developing Centres of Excellence for military related research. Could you expand on that a bit, and could you suggest how you would see these Centres of Excellence developing?

Sir John Chisholm: Let me pick you up on the word failure for the moment.

Q210 John Smith: Your word!

Sir John Chisholm: I think the DIS says that it is not designed as a completely finished document, there are ongoing pieces of work and it says that one of the ongoing pieces of work is in the science and technology field and therefore I would have expected what we are now going to talk about to be covered as part of that ongoing piece of work. What we pointed to is that in covering that ongoing piece of work we would expect the logic which has applied in other areas of the DIS to be equally valid, that within the United Kingdom we need to be thoughtful about the Centres of Excellence that we want to have for the nation. Mr Key mentioned previously the civil research programme run by the Office of Science and Technology where the policy is very much to focus on Centres of Excellence in the UK. I would have expected the same logic to apply in relation to defence science and technology, ie that you would want to encourage the Centres of Excellence and maintain those Centres of Excellence rather than undermining them by spreading the available resources too thinly.

Q211 John Smith: Do you think there is an inherent problem with trying to get government to invest in pure research within commercial organisations as opposed to public bodies, for example our universities? Are you saying you want to see Centres of Excellence develop in existing public research bodies, higher education or whatever, or are you saying that government should be investing more in pure research or blue skies research within commercial organisations like yourselves?

Sir John Chisholm: Yes. I do not think there is any inherent excellence which exists in public bodies or private bodies. Excellence depends upon people and people are where they are. They can be just as easily employed in the private sector as they can be employed in the public sector. I am certainly not saying, as you imply, that Centres of Excellence only exist in the public sector.

Q212 John Smith: Do you not think there is bound to be reluctance on the part of government to invest in such open-ended research with commercial bodies? You said earlier that not only is less being invested and it is not covered adequately in the document but that it is smaller scale and more detailed programmes that are actually being undertaken and some of the bigger work is going to be ignored. I just wondered whether there is not an inherent reluctance on the part of governments to undertake such research with commercial organisations. Is there a case for creating a defence evaluation agency to undertake such work?

Sir John Chisholm: There is a government agency called the Defence Science and Technology Laboratory. If you look at other nations, for instance the United States, it has no difficulty at all applying government contracts to really excellent organisations in the private sector and the United States does quite well from that.

Q213 Chairman: Could I put to you a concern that I felt about the flotation relating to the United States, which was that the United States would feel reluctant to share, with what it might regard as a commercial company in the United Kingdom, secrets that would otherwise have been quite happily shared with an arm of government. What would your response be to that?

Sir John Chisholm: Whether that is true or not, that was dealt with when QinetiQ was formed out of the Defence Evaluation Research Agency (DERA) and at that stage the specific government-to-government research collaboration activity was placed in DSTL. Since then there has been a very good symmetry between the US and the UK in that on both sides of that research collaboration there are government officials, DSTL on the UK side, the US to government labs on the US side, and the actual research work on both sides has been predominantly done in industry. That is true on the US side and it is now true also on the UK side.

Q214 Chairman: How much work is done with the United States by QinetiQ at the moment?

Sir John Chisholm: In total it accounts on an ongoing basis for about a third of our business.

Q215 Chairman: How does that contrast with the work that was done before the flotation?

Sir John Chisholm: Nothing happened at the flotation. Before the vesting of QinetiQ and before the introduction of private capital the amount of work done in the United States by QinetiQ was very small.

Q216 Chairman: Have my fears about the cut off of American work been realised?

Sir John Chisholm: We do far more work, for instance, with the American agency, DARA, now than we did when we were DERA.

Q217 Chairman: That is what I was trying to get at.

Sir John Chisholm: In terms of what QinetiQ does for the United States, it is far more now than it was when we were DERA.

Q218 Chairman: So the direct answer to my question about whether my fears have been realised is no, is it not?

Sir John Chisholm: Correct.

Q219 Mr Hancock: Is that work that you are doing for the American market done in the United States or in the UK?

Sir John Chisholm: We do it both in the UK and in the US.

Q220 Mr Hancock: You said 30 per cent of your effort is now directed to the American market. What proportion of that 30 per cent is carried out here in the UK?

Sir John Chisholm: The majority of the volume of work is done in the US, but the research part of the work is done in the UK.

Q221 Chairman: You drew a contrast earlier when you were talking to John Smith about the approach of the Defence Industrial Strategy to the manufacturing sectors and that to research, technology and innovation. Could you describe that contrast?

Sir John Chisholm: In allocating government funds in the civil research sector, which are predominantly allocated by the OST, their policies have become strongly focussed upon placing the work in the country's strongest research centres; that is a clear policy. There is not such a policy yet, for the reasons that we have described, in the UK because the Defence Industrial Strategy has not yet got to that stage. What we are articulating in our evidence is that we would have expected a policy of that sort to emerge both because it is consistent with what the government's policy is on the civil side and also because it is consistent with the rest of the DIS. When the DIS comes to consider other sectors the DIS says that in order to preserve sovereignty and the ability of the UK to provide the Armed Forces with the best products it should focus upon the areas of real capability in the country.

Q222 Mr Havard: Are you familiar with this concept, which I am only just grappling with, that Lord Drayson came out with about technology trees? It seems to me that the technology he seems to be describing starts fundamentally at the university level and then the laboratories will feed into it and then the SMEs, up to the prime who will deliver the product. That is the production process, turning a concept into a process. The research part of that is implicit in it. Are you familiar with this concept?

Sir John Chisholm: I am familiar with the concept.

Q223 Mr Havard: Is that something that is going to drive this research and technology sub-strategy?

Sir John Chisholm: It relates to the answer I gave to Mr Hancock earlier on, that in order to get from niches of technology into something which is useful to soldiers, sailors and airmen at the end of the day you need an integrating process and this is the tree that you referred to. We play a role in that tree in bringing together technologies from the niches at the bottom end, some of which we do rely on laboratories for but many we source from other people and we bring that together into technologies which we ourselves insert further up the tree into the equipment suppliers who often then insert that into the prime contractors and the systems of systems integrators. So there is exactly that tree where we play a role which is near the bottom but not at the bottom because below us are the niche providers in the SMEs and in the universities.

Q224 Mr Havard: So that is going to generate in part the whole question about the placing of the funding and the processes that go with the whole process then. Is that what I am going to see out of a strategy that comes from research and technology?

Sir John Chisholm: I assume that that will inform the strategy.

Q225 Mr Hancock: This question is about the relationship between your US customers and the British side of the organisation. We are constantly told about the problems of technology exchanges and the restrictions that the Americans put on it. Are the same restrictions being put on you with regard to British-based technology and the way you can share that with the Americans?

Sir John Chisholm: We have to seek export licences.

Q226 Mr Hancock: Is that easier for you to get for the UK than it is for you to get from the US to bring it to the UK?

Sir John Chisholm: I would just make a general comment. My perception is that it is an easier process to go from the UK to the US than from the US to the UK, absolutely.

Q227 Mr Hancock: Is that going to cause you problems as more of your market is in the United States?

Sir John Chisholm: We have a huge capability in the UK and nowhere as strong a capability in the US. So our strategy is very much focused on serving our UK customers and also serving US customers from the UK. That is good for the UK. Our predominant technology flow is in the direction from the UK to the US. That is an issue for us because it sometimes limits our access to the US and it limits what we can do in the US.

Q228 Chairman: Sir John, thank you very much indeed. Is there anything you would like to add to what you have said or do you think that in your memorandum and what you have been able to say today you have covered the ground?

Sir John Chisholm: You have been very generous with the time you have allocated to me, Chairman. I am very happy.

Chairman: Thank you very much indeed for your evidence.


Memoranda submitted by BAE Systems and Defence Industries Council

Examination of Witnesses

 

Witnesses: Sir John Rose, Chairman of the Defence Industries Council (also Chief Executive, Rolls Royce plc), Dr Sally Howes, Secretary of the Defence Industries Council (also Director General, Society of British Aerospace Companies), and Mr Mike Turner CBE, Chief Executive, BAE Systems, gave evidence.

Q229 Chairman: Welcome to all three of you. We are very grateful to you for coming to give evidence about the Defence Industrial Strategy. I wonder if I could start off by saying that in your memorandum you welcome the DIS but you state that "It will be important for the MoD to provide further clarification on what the report means for the whole of the defence industry ..." Sir John, welcome. Would you like to give us an idea of what you would like to see by way of further clarification?

Sir John Rose: I think that will happen over time. The point is that this is a strategy document and the key of any strategy is that it needs to be implemented, and we will need to be very engaged with MoD, as industry and through the trade associations who are partners with industry, to ensure that the steps are taken and the changes are made both within the customer and within the supply base to ensure that we achieve the objectives that have been pretty clearly set out in the Defence Industrial Strategy.

Q230 Chairman: What about the fears that have been expressed by some people that some small and medium scale defence companies might gravitate to other sectors, such as the oil sector, do you have any views about that?

Sir John Rose: In some ways I think the DIS should help rather than hinder the SMEs. The whole objective of the DIS is to create greater transparency about the opportunities that are available to companies in their dealings with the defence customer. As you know, if you are going to try and make decisions about where you invest your money then having some clarity about where you will get your returns is pretty important and therefore this is a good first step in improving the transparency both for the larger companies that interact with the MoD and for the smaller companies.

Q231 Chairman: You said in some ways the DIS should help SMEs. Do you think there are ways in which the DIS would not help SMEs or would hinder them?

Sir John Rose: I do not think there are any ways in which it would hinder the SMEs at all. The big step forward is in transparency.

Q232 Chairman: Do you think there is sufficient coverage within the DIS of SMEs?

Sir John Rose: I think there is. We have got to be clearer about the role of the strategy and the customer. The SMEs are part of a supply chain. Some of them will be direct suppliers to the defence customer and some of them will be suppliers to the prime. In both cases it is helpful for them to know the likely direction of investment either in the primes who are their customers or in the MoD who is the direct customer. The SMEs were involved in the debate that took place around the creation of the DIS largely through the trade associations, of which they are members, but also with representation on the DIC, so they got a good voice in the conversation. It was equally the case that the primes talked to their supply base to try and make sure that they understood the direction that this debate was taking, but my colleagues may have views to add to that.

Dr Howes: I think there has been a tremendous amount of activity working with supply chains in the industry over the last few years. Some of that is industrially driven and some of it has been very driven by MoD itself as it has taken a greater interest in supply chain relationships and supply chain management. I would agree with Sir John that the direction that the DIS has given as to where the market is going, how the customer wants to be, how it wants to buy, gives tremendous clarity for those supply chain improvement programmes.

Q233 Chairman: Do you think the MoD and the DTI do understand the supply chain and the best way to manage them?

Dr Howes: For the MoD it is the start of a journey. I think there has been a lot of honesty that there is not a tremendous visibility right down to the bottom. I am not sure there could be because some of the supply chains are very large and they are very complicated. That is just the world of defence business as we see it today. So I do not think MoD could expect to have complete visibility of that, but I think that it is moving in the right direction in terms of working with industry to try and understand those relationships. The DTI, in extending that into the regions with colleagues in the RDAs and with the devolved administrations as well, has tried to get a focus through things like the Manufacturing Forum, the Aerospace Innovation and Growth Team and the Electronics Innovation and Growth Team. A lot of that work has gone on the effectiveness of the supply chain. So no longer is the DTI looking at companies as isolated pillars but it is trying to look at performance across the supply chain. I think we are all moving and growing in the same direction. What the DIS now gives us is the customer end to really stimulate the right kind of supply chain improvements for the future.

Q234 Chairman: So the Defence Industrial Strategy is the start of the journey for the MoD and the defence industrial policy was not?

Dr Howes: Following the publication of the defence industrial policy the MoD did begin this focus on supply chain management and supply chain relationships, but I think the DIS will give it the focus that it needs. I think for me, in the document itself, on page 28, there is a diagram in there that actually describes where the MoD has been in its procurement and what its vision is. I actually think that this is a very helpful diagram for us all and particularly for industry because this shows the extent of the change. If you imagine the implications of that in the supply chain, yes, it is the start of the journey because there is clearly a lot to be done.

Sir John Rose: I think the biggest contribution to the SMEs is the recognition that having a successful domestic industry is a key objective. For the SMEs having a successful domestic industry is crucial. SMEs have a relatively short reach. Many of them tend to be taken to market through the primes or the sub-primes or the major integrators and that reach tends to be national and not international because by definition they are small- and medium-size enterprises, they cannot afford necessarily to enter other markets and it is difficult to do so and expensive to do so and takes a lot of time. So the best thing for the SMEs is a successful industry domestically.

Q235 Mr Borrow: The Defence Industrial Strategy is important in the sense that it sets a framework within which industry can operate, but the assumption behind the strategy is that industry itself will need to reorganise and reshape itself to meet that framework. Could you say a little bit about how you see that reshaping taking place and in which sectors there will be mergers and which sectors will be most involved in that reshaping?

Sir John Rose: I think we all have views on that. I think it is impossible to predict. I think industry as a whole responds to its customer. We do that in the commercial sectors and we do that in the defence sector. We will respond as an industry to changes that take place in the MoD as a consequence of the implication of the DIS. Clearly there will need to be changes in the MoD in terms of the way that they operate with industry. I could not possibly predict what will happen in terms of the central consolidations in particular. All I would say is that the nature of industry has been that over time the supply chain has become more consolidated because at the top of the supply chain there is a drive for simplicity. Let us take as an example Rolls Royce. If we developed an engine in the late Eighties we would have had 250 or more suppliers; our latest engine has 71. They are bigger and within that there have been some system integrators who have taken on more responsibility and they need to be bigger because they take on more risk, they have to take on the investment requirements, the R&D requirements and so on. I think the industry will simply respond to the demands of the customer in the way it structures itself because that is what industry does.

Dr Howes: It is probably worth just saying that on the whole when you speak to companies further down the supply chain the DIS is seen as a good opportunity for industry to transform and to prosper as long as it is able to invest and I think that will be the challenge over the next year as the sector strategies begin to develop. Many of them have milestones this year to do with setting up partnering agreements and deciding the future. As those begin to mature I think we can then judge what sort of reshaping there will be in industry.

Mr Turner: I believe industry and businesses will go where the market is. BAE Systems is a global defence company. That is why you have seen us expand in the United States, which is clearly the most important market for defence research, technology and procurement. You have seen us expand in other parts of the world like Australia and Sweden and South Africa and indeed we are now investing in Saudi Arabia in line with the government requirements of the King and the Crown Prince there to see investment in skills and employment at the highest level in Saudi Arabia, and clearly there is a market in those countries. The good news for the UK now is that at long last we have a DIS in the UK and my board and my shareholders at long last can see the possibility of a sustainable profitable future for the business in the UK and that we can, as we do in other parts of the world, supply the highest level of capability to the Armed Forces. That is what we are about, the highest level of capability wherever we operate in the world to those Armed Forces in America, Sweden, South Africa, Saudi Arabia and in the UK but also making a return to our shareholders. Industry goes where the market is and now that we have a DIS I think there is a strong market in the UK which was not there previously.

Q236 Mr Borrow: Specifically on BAE Systems, you may not be able to divulge very much at the moment, but is the Defence Industrial Strategy affecting the way in which your company plans for the future and reconfigures itself and reshapes itself within the UK?

Mr Turner: Absolutely. The basic shape of BAE Systems has evolved over the last few years. You have seen us grow in the United States because it is the most important market, you have seen us reduce our investment in businesses in Europe because we believe that there is a real question mark about the future of defence in Europe compared to other parts of the world, and you have seen us investing in Saudi Arabia. Now that we have this strategy in the UK I think there is real potential for the UK defence industrial base which we did not see before.

Q237 Mr Borrow: There has been quite a bit of talk in the press in the last year or two of a merger or some collaboration between BAE Systems and another major company in the United States. Would you say that the Defence Industrial Strategy affected those issues or is that still a live issue?

Mr Turner: I think what the Defence Industrial Strategy has done is encourage BAE Systems to remain and to invest in the United Kingdom. The talk in the press some years ago about a merger was all part of a recognition by the board that we needed access to US technology. The UK no longer invests sufficiently in R&T, as I think has already been said, and therefore we needed access as a global defence company to the world's most important market. Clearly with the weakness of my company a few years ago one way of accessing the United States would have been by a merger with one of the big players in the United States. I think that is far less likely now. We are a much stronger company now and we have managed to grow organically and by acquisitions in the United States. We are now an $8.5 billion turnover company in the United States. We have access, therefore, to other technologies, to the market and therefore a merger strategically is no longer necessary for BAE Systems.

Q238 Chairman: And you say it is far less likely.

Mr Turner: It is not necessary for us now to execute our strategy by a merger, but it does take two to tango and at the moment I can assure you there is nobody talking to us. We will keep looking for organic growth in the United States and acquisitions in the US. The budget going forward in Congress for 2007 is $73 billion on R&T, it is huge and it is very difficult to see how the UK and Europe can match that. If the UK Armed Forces are going to have the very best capabilities that they must have to peace keep and peace make then the UK has got to have access to the very best and that is what we intend to do.

Q239 Chairman: When I asked you whether it was far less likely, as you had previously said, you said it was less necessary but you will still be looking. Can I press you on what you previously said? Is it far less likely?

Mr Turner: It is far less likely, yes, but not impossible.

Chairman: I was not asking for a commitment written in blood.

Q240 Mr Hancock: Sir John, can I take you back to your opening exchange with the Chairman when you said that one of the benefits to small- and medium-size enterprises would be transparency. I was not quite sure I understood where the advantage would be in that.

Sir John Rose: I think it is the simple business model. I think there is an assumption that the defence business has been quite easy. I think it has always been a very difficult business because it is quite difficult to predict demand. It is difficult to predict what is required, when it is required and how much will be required. In the commercial sector you have the ability to judge demand, you have population growth or travel, the requirement for electricity or whatever it happens to be, GDP growth. If you are going to make investment decisions, you want to do them with a sensible view forward of when you are going to get a return. John Chisholm made some clear points about the time to market and the time value of money. If you make an investment and you are significantly delayed in getting a return on that investment it is a very bad thing for you and therefore transparency, visibility and being able to make sensible informed judgments about where you are likely to get a return is absolutely necessary for a company that has to satisfy shareholders, whether it is private companies or publicly floated companies.

Q241 Mr Hancock: Would there not be a degree of nervousness then for some companies reading this strategy, where it states quite clearly that new platforms are to have long service lives, to learn that future defence business will be supporting and upgrading them? That by its very nature would make it very difficult for some companies to retain design and research capabilities that might have been there if that was not the case. Most work in the future will be on updating what is already on a platform rather than bringing new platforms into place. Does that not cause some difficulties for industry itself?

Sir John Rose: Oddly enough, I think it may be very positive, the recognition that that is going to be what is happening and that mid-life upgrades and so on, spiral development, is the way that we are going to work and that continuous technology and insertion and improvement is the way forward. The truth is that platform lives have always been very long. The B-52 is likely to be based on existing commitments and 80-year old aircraft when it goes out of service or it may even be 100-year old aircraft. It will have had technology insertions along the way, but when it started people did not think like that. If we go into the process believing that that is what will happen we will be prepared to take product to market faster in its initial stages and then recognise that in time, as technologies become available, we can upgrade and improve the platform, which is what we have done, but it is a recognition today, right from the start, that that is the way we are going to conduct business.

Mr Turner: It is a recognition of what the reality is. There has been far too much attention paid by MoD in the past to the initial side of procurement. When you look at the expenditure through life, it can be up to four times on support and upgrades of weapons systems. The fact that the MoD is outsourcing more to industry because it can be done cheaper and more effectively is a real opportunity for the supply chain to play a much more significant role. I think it is good to see the focus on through life support and upgrades. The fact that the primes in the UK can now see a long-term future in that regard is not only a benefit for the primes but for the route to market for the SMEs which is far clearer and more specific than it has been in the past. I think it is a very good thing.

Q242 Mr Hancock: The strategy also states that the MoD themselves do not envisage needing to design and build a future generation of manned fast jet aircraft beyond Typhoon and JSF. If JSF was to fail and not be delivered, would we be in a position to marinise our own version of Typhoon? If we were to go down that line, in view of the French interest in them buying one of the carriers, would we be interested in doing a joint venture with the French on that version? Is it something that industry has the capability to deliver or would want to deliver? If we do not have any capability or need for a fast jet aircraft in the future, how does the company see their future in that regard?

Mr Turner: Of course, we are talking about a long time into the future. We have a lot of work to do on fully developing Typhoon. As you know, it was initially designed for both air-to-air and air-to-surface capabilities. So far all we are doing is optimising the air-to-air and, in due course, we will proceed to optimise the air-to-surface. There are many, many years of further development for Typhoon and work for our engineers and for our shop floor in the years ahead. Joint Strike Fighter has a long, long way to go. It is a very complex programme. It is an excellent programme that we, BAE Systems, and, indeed, Rolls Royce are involved in. There will be a lot of work for many years to come. It is important, as you know, that we obtain the technology in the UK from Joint Strike Fighter so we can play that role in supporting and upgrading the fighter when it eventually comes into service. I am sure there will be delays on JSF - these weapons systems are incredibly complex - and when it comes we do want to play a role in supporting and upgrading it, but with Typhoon, with Hawks, with Nimrods, with JSF and with exports we have a very significant future that we can look forward to.

Q243 Mr Hancock: The Minister, in answer to a question yesterday in the House, said that they had contingencies from A to Z on the understanding that if JSF did not materialise they had a whole series, and he actually went through the alphabet, but did not tell us what they were. I am interested to know whether or not it is possible for you to foresee a situation where Typhoon could easily be adapted. The time is not that long. In eight years we will have one carrier in the water. There is no certainty that we will have the plane to follow for that.

Mr Turner: I am not sure when we will have the carriers in the water. That is still to be determined.

Q244 Mr Hancock: The Government gave evidence here saying that they were sticking to their programme, which suggests that by 2014 there should be one of them floating in Portsmouth harbour?

Mr Turner: We are leading the programme and we do not know when we will be able to give an in-service date or, indeed, a budgetary cost for the programme.

Q245 Mr Hancock: Maybe we should have asked you, not the Minister.

Mr Turner: That is where we are, and hopefully in the next 18 months we will have a better view of the in-service date and the budgetary cost for the carriers. Indeed, it is possible to navalise Typhoon. It is not what we would recommend, because if Joint Strike Fighter proceeds, and we believe it will, I think, in terms of capability for the Armed Forces of the UK, it is the right aircraft, but, indeed, as Lord Drayson has made clear, there needs to be a fall-back in case something goes wrong. Therefore, we would suggest there should be an investigation into navalising Typhoon as very much a fall-back solution. We do not see any other fall-back solution.

Q246 Mr Hancock: Is that going on?

Mr Turner: No.

Q247 Mr Hancock: You have not been asked to do that?

Mr Turner: No.

Q248 Mr Hancock: You are not doing any work on your own bat on that?

Mr Turner: We have done some work on our own. We know that it is possible. What we need to do is to do some more funding work to look at what would be involved in navalising Typhoon, what the programme length would be and how much it would cost.

Q249 Chairman: But it is not just in case anything should go wrong that there needs to be a fall-back, surely. If there is no fall-back, then it makes it more likely that it will be harder to get technology transferred from the United States, does it not?

Mr Turner: That is my view.

Q250 Mr Havard: I would like to ask you not about changes in industry but changes in the MoD. The Minister has said in the past that they would need to change also in order to accommodate the new strategy. What is your view at the moment of what the MoD is doing in terms of change? Are these changes taking place or do you see a static organisation? What is your view of the changes that are taking place in the MoD to accommodate the Strategy?

Sir John Rose: I think it is too early, candidly. The Strategy was only published in December. There is evidence of change already, but you have to remember that you have got an organisation that has spent a long time operating in a different way and, therefore, inevitably, it will take some time before the sorts of changes that are implied by the Defence Industrial Strategy really manifest themselves, but there is no doubt that the conversation that took place between industry and the Ministry of Defence around the DIS was as helpful a conversation as we have had in the last 15 years. It was conducted well, it was very open, the way that it was handled encouraged openness on both sides and I think the outcome of the Defence Industrial Strategy reflects that. Clearly, the Strategy is only as good as the implementation.

Q251 Mr Havard: Perhaps we can come to that a bit later on. The other thing, interestingly, that you said, Minister, earlier on was that perhaps in the past the emphasis has been on acquisition and the changes are going to have to be related to through-life processes and upgrades. The question has been raised in the past that it has been too slow and too expensive in terms of the MoD's response for industry and that the MoD's procurement processes and decision-making processes need to be in some way revised. What is your view of that? We have taken some evidence about the DPA and all the rest of it. There is both the procurement decision-maker and the actual process that delivers it. What is your view of changes there?

Mr Turner: It takes a long time. I think the big companies like BAE Systems can afford to continue with studies and with quotations and negotiations, but for smaller companies - I was on the Board of Babcock's until last year - it is very expensive continuing to run these competitions and delays happen. Yes, we would like to see the acquisition process speeded up, but I think fundamental to this is the investment that needs to take place at the beginning of a programme's life. In the past we have not as a nation invested sufficiently in derisking programmes and establishing the realistic in-service dates and budgets for these programmes, and that needs to take effect. We have shot ourselves in the foot as a nation by going out there and saying, "It will be in service then. It will cost so much", but we have not done sufficient work. These are highly complex weapons systems, as I have mentioned, and we need the early study works, indeed, to see if the programme is viable or not. We have not done that in the past. I think with the DIS we are moving away. There is a recognition that we will be shooting ourselves in the foot as a country and undermining the defence industrial base by making it look as if we do not give value for money when in fact we do. If you look at the value for money that the UK defence industrial base gives compared to anybody else in the world in terms of cost and programmes and sophistication of capability, it is second to none, and we need to stop doing what we did in the past.

Q252 Mr Havard: The Defence Industries Council is, presumably, a body that some of these discussions will come back to in some fashion. The Integrated Project Team, the whole question about project management processes, has been at the heart of this whole discussion about the flexibility and fleetness of foot, or otherwise, of the DPA and other processes. What discussion is going on in the Defence Industries Council in relation to that?

Sir John Rose: That is a very broad question. The DIC is really about policy and strategic issues. It is not a programme management body. It is there to deal with the overview, as it were. There is a breakdown structure that goes below that and that will report into the DIC.

Q253 Mr Havard: It presumably informs the work of the MoD itself and the DPA, and so on, in how it should make its change?

Sir John Rose: Yes, it does. You will remember, we meet a couple of times a year at the NDIC and those meetings are now scheduled in, we hope, for the next 18 months or so. We meet as a DIC reasonably regularly and we take input from the team leaders who are interfacing with the MoD in the specific areas that we have agreed that they should, but, ultimately, we are there to suggest strategy, to inform policy and to monitor progress. Sally, you are the Secretariat, why do you not add to that.

Dr Howes: There are a couple of specific things that are now under way within the MoD, particularly looking at acquisition change. Tom McCain is leading a review looking at what change is needed to implement the DIS. It is a small team within MoD, which is appropriate, but industry is involved in that; so people are contributing their thoughts about the acquisition process and their experiences into that. That is on a short time-scale - it is going to be reporting at the end of May. Certainly the outcome of that kind of work is the sort of thing that the DIC would be very pleased to look at and to provide comments on, but I think there is also something much more practical and tangible that is going on which, again, was defined in the DIS. Two Pathfinder programmes were defined. These are activities where MoD and industry will work together to explore what through-life capability management is and the implications of that on the MoD side and on the industry side as well. Some of the joint industry MoD groups that Sir John was describing were, if you like, the source of performing these ideas during the last year. It was picked up in the DIS, it is being taken forward now and we think these will be very valuable experiences to push through. They are not project-by-project, they are collections of projects, which is also very helpful. It is trying to find what the new acquisition processes should be.

Q254 Mr Havard: So this is giving a real description of this diagram on page 29?

Dr Howes: That is exactly right, yes.

Q255 Mr Hancock: Can I go back to the point about derisking. I think there is an issue there and I think the two carriers and the way that is being done possibly is the start. Just to give an example, the Astute submarine programme is a billion pounds over budget and four years late. I cannot imagine that the derisking on that would have been anything but very expensive. Who pays for the derisking?

Mr Turner: The derisking on Astute that GEC received was zero. They were encouraged to enter into a competition to design, develop and supply three nuclear attack submarines with no prior knowledge of any of that, and I think that it is completely wrong for the defence industrial base of the UK. They clearly as a company had a strategy to go into a prime systems capability. At the time it was the only way that MoD was prepared to do business. What we are now seeing, and what I think is well recognised, is that is the wrong way of going about this business. Indeed, Smart Acquisition many years ago recognised that investment upfront - derisking - paid for by the customer: because it is the customer that has to take that risk until such point in time as the risk is understandable by industry and then industry can take the risk on.

Q256 Mr Hancock: But I am interested to know who fixes the price for the derisking?

Mr Turner: There is no price for derisking.

Q257 Mr Hancock: I think you said the customer pays, but the Government cannot just say, "Tell us what it is going to cost for you to take all the risk out of this"?

Mr Turner: No, there are milestones. In a design and development contract you have milestones for the programme and, as those milestones are achieved, you then move on to the next milestone. These complex high-tech programmes have to be milestone driven, and, yes, it is not an open-ended budget, but what MoD now do is allow a certain amount of money to get to the next milestone and, if sufficient risk reduction has occurred, you move to the next milestone. When you get to a sufficient point that you fully understand the programme and have derisked it to an acceptable level, then industry can step in and take the risk, but not until then.

Chairman: Can we move on to partnering arrangements.

Q258 John Smith: My questions are directed to Mr Turner. In a number of areas now the MoD is moving towards long-term partnering agreements. Your company is becoming, in a number of cases, the sole supplier of these long-term contracts. Two years ago you told the Public Accounts Committee (and you referred to it earlier), "There are far more attractive markets in the United States if the MoD's terms of trade do not change." Have those terms of trade now changed, do you think, to your company's satisfaction and, if so, in what ways?

Mr Turner: I think what has happened over recent years is that the terms of trade have changed in the way I have described with the customer (MoD) taking that initial risk recognising that it has to take that additional risk in the complex design and development phase and then industry taking on the risk when it is understood. For BAE Systems, I think the change in the terms of trade and the DIS actually having a strategy for the defence industrial base for this country is very, very significant. Whilst the US remains a more attractive market in terms of the attitude towards profit and in terms of wanting industry to make a 15 per cent return on defence contracts, where it is about eight per cent in this country, therefore if you were starting from scratch you would not be investing in the UK, but we are in the UK and we now believe that, with those profit rates only at eight per cent compared to 15 per cent in the US, there is sufficient attraction in sustaining the capabilities in the UK now because of the DIS and because of the more acceptable terms of trade. In fact there are a significant number of key plus points to come out of the DIS: the recognition of partnership instead of competition, partnership that recognises the real issue is value for money not just competition to find the lowest additional cost and then real problems downstream, it recognises partnership, it recognises the importance of systems engineering and integration at the highest level in air, land and sea - and that is where BAE Systems plays a role. The UK now is becoming a far more attractive market. Even though there are lower profit rates, as I said, we can see a sustainable business in the UK forum for our company.

Q259 John Smith: I think most people agree that the Strategy is welcome in terms of identifying future market opportunities and in what direction Government is going in the future in terms of its defence thinking, but one of our witnesses in an earlier session suggested that the shift away from competition towards partnering is not necessarily in the interests of your company or other defence companies in this country in the longer term because you will not be exposed to such competitive pressures in the UK domestic market. Is that a concern?

Mr Turner: No, I think competition has been a disaster for the UK defence industrial base. I think, frankly, if it had continued, you would have seen the end of prime systems capability in the UK, UK owned companies. We are not in the fortunate position of the United States. They have a number of primes. They have Boeing, Lockheed, Northrop, Raytheon, GD, and, indeed, now, BAE Systems North America. All we have in the UK, overwhelmingly, is BAE Systems in air, land and sea and, in fact, now we can see a sustainable way forward with a strategy for the first time ever in this country, championed by John Reid and Lord Drayson, and thank goodness for that. If competition had continued, allowing foreign companies to play the UK tactically, I think it would have been a disaster in the long term, and you would have seen the exit of prime systems capability in the UK with overseas companies offering lower-tier technology to UK companies but then the through-life support and upgrade would not be possible, it would be dependent on foreign entities.

Sir John Rose: May I just add to what Mike has to say, which is that it is not only partnership. I think it is really important that we remember that the DIS is very clear that there are areas where partnership is the right answer and there are areas where competition is the right answer. None of us, as suppliers to the MoD, can make sense of a business that is simply about supplying, in a partnership arrangement, to the MoD. In order to be successful we have to have a product that is capable of being sold overseas against competition. There is plenty of competition around, with no shortage of competitive pressures in all the markets which we try and serve, including the US, and, like Mike for Rolls Royce, the US is our biggest defence customer, and it has been that way since the early nineties, so we have had plenty of exposure to competition. The danger was that the sort of competition that was being exercised here meant that you were competing against a marginal cost supplier, in effect, and that does not make any sense if you are trying to retain a sensible industrial base. That does not mean that you have to retain all capabilities, it does not mean that partnership is the only answer, but it is one of the answers, and that is what the DIS says.

Q260 Chairman: Mr Turner, when you said that competition has been disastrous for the defence industry, would you repeat it as baldly as that or were you referring to competition from overseas?

Mr Turner: I think that the competition policy of MoD allowed overseas companies to see an opportunity in this market to wipe out the prime systems capability of the UK indigenous defence base. BAE Systems, British Aerospace, did not need a competition policy to say it needed to be competitive globally. Look at how many Hawks we have sold overseas, how successful we have been as a business in exporting. I believe we are the number one exporter from the UK. We only export because we are competitive. We are competitive in world terms.

Q261 John Smith: Again, we have received a number of statements from witnesses expressing deep concern about the future development of BAE Systems being in a position of the sole monopoly supplier taking on board the views, in terms of international competition, of a global market. A number of very strong comments have been made in terms of BAE Systems possibly developing a strangle-hold on British defence procurement policy and that this document, the Defence Industrial Strategy  - and this is contained in written submissions to this Committee - conflates the interests of a single British company with the interests of this country. What power does a British Government have to retain your company in this domestic market if you choose to go elsewhere? It will have no power at all - not at the moment, but this is a possible future scenario - because it has no other supplier whatsoever to turn to within the UK domestic market. What are your views on that?

Mr Turner: BAE Systems (British Aerospace) for decades has had a monopoly on air systems, but it has been very good, very healthy for the UK. It has provided the best aircraft in the world in training and fighting in fighters, and not only for the UK but for the world air forces, and it has provided a very healthy income to the United Kingdom. It has been good for British Aerospace in the past, but it has also been good for the UK. We have now a very significant position also in land and naval, and I hope that we can go on in land and naval, as we have done for the past decade, to be a success for BAE Systems in the UK. It has been very good news. You are right, the Government has no real way of stopping BAE Systems leaving these shores, but I can tell you that with the DIS, backed by John Reid and Lord Drayson, it is now becoming an attractive place to do business, which it was not. It was a very unattractive place to do business in the nineties and the early part of this decade, and it is now changing, and that is good. It is good for BAE Systems and it is good for the UK.

Q262 John Smith: One final question. One of our witnesses, Professor Hartley, suggested that if this monopoly situation were to develop extensively within the British defence market, there might be a case for regulating your company as a utility. Do you have a view on that?

Mr Turner: We are regulated by, in 1968, the Ferranti affair, with outrageous profits. There was then the Laing Report that said that we needed a profit formula based on the cost of production and capital employed. That is what we have got. We very much have a regulated profit. I am afraid it is set at eight per cent for my company, compared to 15 per cent in the US, but at eight per cent, with sensible terms of trade and the DIS, we can see a return on capital for our shareholders. We could not see that before. We are regulated.

Q263 Mr Borrow: Can I come on to the specific area munitions. Under the DIS, BAE Systems have a dominant role in supplying munitions to MoD. Obviously there is an issue at the moment around the possible closure of Bridgewater and Chorley ROF sites. The closure of those sites would lead the MoD to be dependent upon foreign suppliers for certain munitions because they would no longer be produced by BAE Systems within the UK. I want to ask Mr Turner the extent to which that is a problem for the MoD. The DIS in many ways is seen as a document which strengthens and supports the defence industries in the UK, but at the same time we are seeing, or potentially seeing, the closure of capacity and dependence on overseas suppliers for key parts of military equipment or, in this case, munitions?

Mr Turner: In fact, we are being consistent with the DIS, because it is quite clear that the MoD cannot afford to invest in R&T and procure everything from the UK defence industrial base. In the case of Chorley and Bridgewater, indeed, we are closing those sites because it is not economic for BAE Systems and the UK to keep those sites open, but where we are investing is in insensitive munitions, the raw materials (the explosive), when they are supplied (hopefully from a reliable source), and, indeed, security of supply will be an issue when we go to new suppliers for those raw materials. Indeed, the investment we are making in mixing those explosives into insensitive munitions, it is a world-beating technology that BAE Systems has and it is what we supply to the UK Armed Forces. That is where the DIS is focused, and rightly so, at the top end of technology, insensitive munitions. We cannot afford in this country to keep the supply of raw materials at an economic level. We cannot afford it.

Q264 Mr Borrow: Would you agree that there is legitimate concern on behalf of the UK taxpayer and the UK military that closure of these two facilities could take place before we have actually nailed down and secured long-term supplies of alternative munitions?

Mr Turner: We would not do that. There is no way that we would finish off manufacturing the raw materials that we currently do without being fairly sure that we had a secure supply for those materials for the UK Armed Forces.

Q265 Mr Borrow: Are you in a position to give an undertaking to the Committee this morning that Chorley and Bridgewater will not close until such time as a secure alternative supply of those munitions has been sourced to the satisfaction of the MoD?

Mr Turner: That is part of the process that we are going through now. Absolutely.

Q266 Mr Hancock: Why is it that the product that we manufacture currently is not good enough for you to export to keep the business going in the UK?

Mr Turner: We do not demand sufficient of it in the UK, so we are below critical mass.

Q267 Mr Hancock: There is not an export market for it?

Mr Turner: No. We cannot be competitive at that level of technology, the raw material level.

Q268 Mr Hancock: Why is that? What is the problem there?

Mr Turner: Because other countries can do it cheaper and more efficiently in that area than we can. We invest in BAE Systems in the higher technology.

Q269 Mr Hancock: Is it because of lack of investment in the past in these plants?

Mr Turner: We have to be selective where we invest our R&T, and we have selected to invest our money at the very top end of technology in systems engineering and systems integration. I think it would be wrong to invest in the bottom end of technology. That is not the future for this country.

Chairman: We are moving on to research and technology.

Q270 Robert Key: Mr Turner, I wonder if you can tell us roughly how much your company does spend on R&T.

Mr Turner: We spend about 100 million of our own money on R&T in the UK and about 100 million of our own money in the United States on R&T.

Q271 Robert Key: Sir John, I wonder if you can tell us roughly now much Rolls Royce spends on R&T?

Sir John Rose: We spend gross over 600 million every year, net about 250 million, of our own money. About 20 per cent of our total R&D spend is on research and technology acquisition, i.e. the raw materials of product development. About half of that is spent overseas and half in the UK. We used to spend 100 per cent in the UK.

Q272 Robert Key: Those are very impressive figures, and I would have expected nothing less from world class companies, but is not that amazing compared to the British Government spend of about 250 million a year on R&T? This worries me very much indeed: because right through the Defence Industrial Strategy, on almost every page, there is reference to the importance of investment in R&T. It says nothing about increasing the Ministry of Defence budget on R&T. It says that we have now dropped to 1.9 per cent of our GDP spent on R&T, it laments the fact that countries like China and India are going to be increasing massively their R&T but we are not. Were you as surprised as I was that the Government made no mention of any increase in R&T spend?

Mr Turner: I am afraid it is all part of that disastrous policy that I talked about. We had Peter Levene, in the late eighties, come in and say that we are going to have a competition and we are going to buy more off-the-shelf and, as a result of that, we have stopped investing in this country in defence R&T. This country has had an absolutely tremendous return from the investment in defence R&T, but I am afraid it is not a priority for this country any more. There is a very different attitude in this country to defence and security than I see in the United States, and that is why it is $73 billion in the United States next year and a very low figure in the UK.

Sir John Rose: I think you have got to read the DIS in conjunction with the work of the AEIGT, which did have, at the end of it, a recommendation that was endorsed by the MoD, the Treasury and the DTI for an increase in spending. We have not seen that come through yet, though there is some evidence that there is some increase. In our case we have seen something like a 75 per cent decline in real terms over the last 15 years in MoD investment in R&T. It is part of the point that Mike Turner made earlier about derisking. Historically the MoD invested in R&T that was specific to the defence needs and in demonstrator programmes, which were the mechanism for derisking. We would like to see a return to that because it is very important for the customer and for industry to prove technologies before their insertion, and demonstrator programmes are the key mechanism for doing that. They have proven to be successful in the past, they were key to the success of Typhoon, as an example, but those were demonstrator programmes that were funded in the eighties initially. There is a recognition within the DIS that there needs to be an increase in the amount of R&T spending and that there needs to be a hierarchy that involves the universities, that involves industry and involves the industry partners and involves the MoD. I would just make one slight correction. The tree that you talked about does not have universities, then SMEs, then primes. Very little R&T takes place in SMEs. They participate in some R&T programmes, but it tends to be driven by the larger companies, and the universities are a key part of that.

Q273 Robert Key: The DIS talks too about the importance of looking towards Europe in relations both industrially but also in terms of research. There is quite a lot of duplication in research and technology, is there not, across Europe? Would it be practical for this country to take a lead perhaps in rationalising that, preventing some of this waste in the same way that you suggested there has been a lot of waste in the previous models of defence procurement in the past? Am I right, first of all, in your experience, that there is duplication across Europe?

Mr Turner: There is duplication. You have seen that with Rafael, Typhoon and Gripen. I think the fundamental problem, though, that Europe has got is that it is just not spending enough on R&T generally. There is duplication, yes, but when you compare Europe with the appetite for spending on R&T in the United States, the great concern that we have for our Armed Forces is how are they going to get the capability to be able to peace-keep alongside the United States? That is why we have stressed that when we do acquire from the United States, as we will have to in certain areas because we clearly cannot afford everything in this country any more, we need to get the highest level of technology transferred across to the UK to sustain the capability for the support and upgrade through life. Yes, there is a case for trying to get Europe to get the act together, but who is going to move first? Everybody wants the technology in their country, everybody wants the highest level of technology jobs in their country and there is a very limited amount of resource available anyway for doing it. I am not optimistic about that.

Q274 Mr Crausby: Sir John, the Defence Industries Council tells us that it is keen to work constructively with the MoD to ensure an effective implementation of the Defence Industrial Strategy. How involved is the DIC with the implementation of the DIS and are you satisfied? Is it clear to industry who is responsible for implementing the various aspects of the DIS and in what timescale? The SBAC suggests that ministers are looking to a two-year period for the implementation. Do you agree with that? How will industry in the long-term measure the success of the Defence Industrial Strategy?

Sir John Rose: I think we would all like to input to that answer. I would start by saying that I think Sally Howes has covered a lot of the answer in her earlier comments. We have got the first of our post DIS/NDIC meetings tomorrow. We will have regular meetings with the MoD, and tomorrow very much on the agenda will be trying to work out exactly how we do monitor the progress, but clearly the big items are going to be do we see change in the effectiveness of the programmes that are delivered, do we see changes in the way that MoD procure and are structured and do we see changes in the way that industry interfaces with the MoD? There are going to be a lot of a sub-mechanisms, as Sally mentioned earlier, where we look at different components both through the DIC mechanisms but also in terms of the individual company's interface with the MoD.

Dr Howes: I think all of the actions that were suggested in the DIS are being undertaken one way or another. We are satisfied that the bases are being covered. It is very clear that this is going to require some strong leadership to keep all of this together during the period. As Sir John mentioned, the NDIC is scheduled to meet four times rather than two, which is normal, this year, and we have an agreed timetable for check-points and for looking at the progress of the implementation itself. I think it is early days, but we see activity under each of the headings.

Mr Turner: I can tell you what is happening in BAE Systems on implementation. On air, land and sea, clearly where they were specifically clear in the DIS on the future importance of the highest level of systems engineering and integration in the UK, we have a very senior lead within the company on air, land and sea in discussions with somebody in MoD, appointed by MoD, to agree the partnering arrangements, milestones, in taking the DIS forward. We were fortunate on the land side that Lord Drayson and I, on the day of the announcement of the DIS, signed the milestones for taking land systems support and upgrade forward, and we are now working together on the air side and on the naval side to put similar partnering arrangements in place, to set milestones in place, to prove that we can deliver, as we say we can, against certain milestones. The biggest issue for us, though, is the cultural one, the relationship over many decades now between the DPA and industry. That is where there has got to be the most radical change. We approved, in partnership with the DLO, that there are great savings to be made on support and upgrades by working in partnership to improve the availability of Nimrod Mk IIs, of Harriers, of Tornados, at reduced cost to the taxpayer, and we believe that, by working in partnership and working in a similar way with the DPA, we can deliver savings to the taxpayer on the initial equipment, but I think that is a big challenge.

Chairman: That is very helpful evidence. Thank you all very much indeed for coming this morning.


Witnesses: Lord Drayson, a Member of the House of Lords, Minister for Defence Procurement, Mr David Gould CB, Deputy Chief Executive, Defence Procurement Agency, and Mr Mark Gibson CB, Director General, Business Group, DIT, gave evidence.

Q275 Chairman: Minister, gentlemen, welcome to the Committee to talk about the Defence Industrial Strategy. The Defence Industrial Strategy was originally expected on 20 December, and I think you produced it four days earlier. Minister, I ruined your career, I suspect, by praising you in the House of Commons and saying that it was the first procurement project that I had heard of that actually came in early, yet it was produced at quite a lick. Given that, do you feel that there were any areas which, perhaps because of the quick time scale, were insufficiently covered within the Defence Industrial Strategy? I ought to say in context that it has been generally well received, but, having put that in context, are there any areas which were not as well covered as you would have liked them to have been?

Lord Drayson: Thank you, Chairman. Before answering your question, may I just say that it is with deep regret that I confirm the death of two British soldiers killed by terrorist bombs as they carried out their duties in Iraq this morning. Our thoughts and our deepest sympathies are, of course, with the families concerned.

Q276 Chairman: I am sorry. I was not aware of that. Thank you for mentioning it.

Lord Drayson: Chairman, I appreciate the comments which you have made about the DIS, and you are absolutely right that we set about delivering the DIS to a very tight timescale. The reason why we did that was because we had had clear feedback from industry that they were going to be making decisions towards the end of the year, into the early part of this year, where there really did need to be a clear framework as a good basis to take those decisions. We also knew that we had some important decisions to take on some of our key procurement projects, for example, like Carrier, which were far better taken in the context of the DIS. Therefore, it was important that we delivered it by Christmas. In terms of which areas do I feel were not sufficiently covered, I think we need to recognise that the DIS focused on the areas which we regarded as being the most high-priority in terms of the issues which we were faced with, and therefore there was a difference in terms of the depth into which we went in the different sectors reflecting the relative market conditions and the issues which we faced. Answering your question directly, we do see that there is further work which we need to do to build on what is in the Defence Industrial Strategy around areas such as research and technology - I am happy to go into the detail of what we are doing on that - in terms of areas related to small and medium-sized enterprises and the relationship between the Ministry of Defence and SMEs. These are areas which are covered within the DIS, but we certainly feel that they are areas which we need to further build on quickly this year, and we are doing so.

Q277 Mr Havard: Can I pick up the whole area of SMEs. It seems that the Strategy is an overview strategy in a sense. Within it there are other strategies presaged, like the Maritime Industrial Strategy, and so on. One of the things that interested us was which sort of sectors were involved or not involved. What you are saying is some are more heavily involved than others, but this question of how small and medium enterprises were involved is of particular importance. It has been suggested to us, for example, that some of the small to medium enterprises might look to gravitate to other sectors because they find it too difficult participate in the long term in the defence industry. What is your view of how SMEs are going to be given proper visibility and avoid that problem?

Lord Drayson: I believe that it is vitally important that we do everything that we can to improve the way in which we work with SMEs. I have 20 years' experience of growing and building technology companies from start-up and beyond, and I know how challenging it can be. In this particular industry, because for my SMEs their route to market is through the larger companies, the primes, I think there is a dual responsibility, which is clearly set out in the DIS. There is a responsibility on Government, on the Ministry of Defence, to actively work to find ways to provide the clarity and transparency in an efficient way that small companies, who do not have the resources of larger companies, can digest and manage effectively, but there is an equal responsibility on the part of the larger companies, who are often their route to market, to provide that clarity too. The way in which we are actively doing that is to switch our focus from a specific focus around projects and about companies in terms of looking at the supply chain, and so one of the ways practically we are going to improve this is by assessing the larger companies on the basis of how good they are at having real knowledge of their own supply chains, how good they are at being able to explain to us the technology trees that they have in certain capabilities such that we can see the relative effectiveness of the larger companies in having a real understanding of which SMEs are vital to the production of the defence capability. Also within the Ministry of Defence - it is not published within the DIS, but a lot of underpinning work was done on the DIS in terms of fully understanding these supply chains - we have gone into a lot of detail in the individual sectors and asked ourselves the question: where are the really important areas of skills and knowledge, which companies are they located in and do we have proper visibility of the health of those companies and how they fit into the bigger picture? That is something which we have done in a considerable amount of detail and that is something which we are going to continue to build on. We also need to make the MoD easier for SMEs to deal with, and we have done that by issuing on our website a sort of "who's who" such that small companies can easily look up, if they think they have a service or a product which may be of interest to the MoD, who they need to contact. It is the first time we have done that. That is another example of how we are trying to make ourselves more user-friendly to the SME community.

Q278 Mr Havard: It was suggested to us this morning that part of the difficulty that SMEs who would like to participate in these areas, and do (and some people do not understand that they do currently actually), is that they have national reach, they do not have international reach. There is a responsibility to involve them from that point of view. They cannot really get involved in an international defence market because they do not have the resources to do it.

Lord Drayson: I have spent some considerable time looking at this, and I have been quite impressed when I have gone to see small companies. There are some excellent British small companies who successfully compete internationally in specialist markets - they are really good at it - and we need to make sure that we give them every support that we can. I think we have a very effective organisation in derisking which is pretty much unique within the international market, but when you look at these supply chains it is very clear that in many areas of defence capability there are some vitally important small and medium-size enterprises, and we need to make sure that we have got a clear focus on this, and I think we need to improve the visibility. One of the interesting things for me, coming from the pharmaceutical industry into this job and looking at the Defence Industrial Strategy, was some of the feed-back which we got from the stock market analysts about the defence industry and the lack of clear visibility in the mind of investors of how smaller, innovative, high-growth defence companies grow into larger ones because of the nature of the complexity of the systems, and so forth. I think we need to do more to help the industry have that visibility.

Q279 Mr Havard: The accusation, if you like, that has been made by people who have given evidence to us is that the problem is that you have visibility to some degree of the first level of the supply chain but you are not so good at understanding the second, third levels. If your declaration is that these people are going to help them deliver the key industrial capabilities, you need to get underneath the first level and down to the second and third level. As I understand it, you have made speeches elsewhere and you talk about a commercial services group being established, you talk about work with the trade associations, and so on. Are these part of the mechanisms you are describing to do this work and how is this work going on, apart from what you have already described?

Lord Drayson: I have a personal commitment to make it happen. I have some experience in helping people at the other end in terms of running these sorts of companies. I know some of the challenges from my own personal experience, and what I am driving in the Department is a real emphasis on looking at the way in which we do business, coming up with specific actions to make it easier - I have mentioned some already. We also need to recognise what the Department is already doing. If you look at government policy in terms of the proportion of contracts which the Government would like to see placed with small, medium-sized companies, the MoD spends way more than that, so we are already spending a considerable amount of our defence contract with the small, medium enterprises. We have got a range of initiatives in place. The DIS sets out how to do this, if you like, for 2006 and all the things that we are doing, and it is my job, in terms of being accountable for the implementation of the DIS, to see that these things happen. What I am looking for is that next year (2007) we are starting to see evidence that it is making a difference. I am actively spending amounts of time talking to that community, getting that feed-back to make sure it is making a difference.

Q280 Mr Havard: You have said that you are "assessing" companies in terms of how they actually manage this process themselves, the larger companies, the primes, and so on. As I understand it, you have made statements about the joint management of SMEs by the MoD and the primes. I am not quite sure what that means. All of that is all very well, but the MoD presumably, which you have responsibility for, is changing its practices and taking a particular view. How is that being done in concert with the Department of Trade and Industry?

Lord Drayson: It is very important that this is joined up government, and the DIS sets a good basis for this. This was a joined up process, and we have taken on board a lot of the input which we have had from the DTI on the way in which this is done. It is important for me to stress that it is not about managing companies. It is not our job to manage companies, but it is our job to make sure that we properly understand and manage the complexity of the supply chains. The challenge within defence is many of these systems which deliver the military capability are very complex and involve many different companies coming together effectively. The way in which we do that jointly with the large companies is both the MoD and the larger primes having clarity on, for example, the technology tree. If you take a particular capability and you look at what is the tree of support for that technology going right down into the research, sometimes into the universities themselves, you have clarity over that and the way in which we judge a large company is on how well does that company really understand this and does it actively manage it. If not, this is where we need to work together to encourage that to be done better.

Mr Gibson: To add to that from a DTI perspective, we have a small aerospace marine defence team of about 25 people, with about five people working on defence, but we do have a formal relationship management with the 15 largest aerospace and defence companies. We have quarterly meetings with them and we have reinforced the messages in agreed Government documents like the Defence Industrial Strategy. We also work pretty closely with the regional development agencies, who have clear sector leads now to the south-west RDA, and we expect them to have a good relationship with the supply chain and to work with them to try and improve productivity, and there are regular meetings between the DTI's aerospace and defence team and the RDA contacts who lead in this sector. We are trying to reinforce the messages all the time, both in the primes and through the RDAs, with the supply chain.

Chairman: So the sector lead for defence is in the south-west.

Q281 Mr Havard: For England.

Mr Gibson: For England.

Q282 Chairman: BAE Systems is based all round the country but its centre seems to be in Wharton, which is not in the south-west. How does that work?

Mr Gibson: The north-west RDA does take a really close interest in the aerospace industry. The Chairman of the north-west RDA is Bryan Gray, who is on the Aerospace Leadership Council. He has been involved in the whole aerospace strategy for the last three or four years and he takes a particular interest in aerospace issues; so he is closely involved and talks to BAE regularly in the north-west.

Q283 Mr Crausby: The Defence Industrial Strategy states that industry will need to reshape itself, and you, quite rightly, are demanding a substantial change in a number of sectors. Is industry willing to reshape itself into the shape that you require, how painful will this be in terms of jobs and over what timescale do you envisage that reshape?

Lord Drayson: This is a ten-year process. The point of the Defence Industrial Strategy is to set out clarity to industry about those areas in which we expect to have an increasing requirement, those where we expect a decreasing requirement to take place and to give industry that clarity to enable them to plan ahead. This is not about changes happening tomorrow, next month, this year. It is about changes which need to take place over a period of time to get alignment between the defence industry's capabilities and our capabilities in terms of our security and defence priorities. The pain comes from that change, but change is always painful. One of the big changes which we are asking in some sectors is for industry to put less of a focus on the design and development of new platforms and more of a focus on the insertion of upgrades and new capabilities and through-life maintenance of existing platforms. That is, for some companies, a change of culture in terms of their type of business and that is difficult for them to do. It is for industry, though, to step up and do it. It is not, we believe, the role of government to manage this process. The role of government is to set out, as we had in the DIS, what it is we need, what our priorities are, where we regard it as essential to our defence interest to have a capability in the United Kingdom and then to expect industry to respond to that. The pressure on industry to do so, I think, will come both from the fact that this clearly sets out where the key growing markets are, and you would expect management to therefore reflect that. We need to work with industry to facilitate this process and to manage it as well as possible, and I am saying to industry, pretty bluntly, this needs to start now. The evidence that industry is responding to it, I think, is beginning to be there. I have been encouraged by what I am seeing just in the first few months after the publication of the Defence Industrial Strategy. In some sectors we are asking for companies to come together into structures to address inefficiency. It is patchy, as you would expect. There are some companies who are looking to see whether or not this is really going to happen and then really getting involved in it. There are some companies who seem to really get it and are getting on with it now. Our job within the Ministry of Defence, and my job in particular, is to encourage them that the Defence Industrial Strategy is a plan for action, it is not just a policy document and that we do expect industry to respond and get on with it in 2006.

Q284 Mr Crausby: Is there a danger that some companies will focus on a non-defence future, the companies that want to do that, and that the reshape will become a different shape to the one that you really want? How do we protect ourselves against that risk?

Lord Drayson: We have set it out very clearly. We have said that the number one priority, as set out in the Defence Industrial Strategy, is putting the defence needs first. That is something which has been a real achievement of the DIS, giving industry the clarity of how our defence capabilities are going to be linked to the defence needs going forward, and we have said very clearly that we have come to the conclusion that having a healthy defence industry in this country is strategically important to our defence interest. Therefore what we are indicating is not a decline in the demand for defence products, we are indicating where the shifting priorities are as the world is changing. That gives great opportunity to industry. In fact, the way I would put it to industry is that, given the nature of the clarity which the UK has now given, given the nature of the tempo of operations which our Armed Forces undertake, if industry responds to the DIS, it is going to lead to it producing products and services for which there will be a clear world market. Some of the responses we have had from some of the international pilots which we have to the clarity of the DIS back that up. I do not think we need to be worried about companies exiting the defence market and looking towards the civilian market, and I think the way in which we have seen commentary about the DIS in the press and analysis suggests that that is correct.

Q285 Mr Hancock: Could I take you a little further down that road. You said in an article fairly recently that there will be job increases in some sectors but inevitably there will be job reductions, but you were not specific about which sectors you were talking about. In an area like mine - I represent Portsmouth which is heavily dependent on defence industries - that would send nervous shivers down people's spines. Would you care to clarify that a bit more today?

Lord Drayson: Yes, I will give you two examples, one of each. In terms of where we think that there are going to be job decreases, it is going to be in areas such as the complex weapons area whereby we can see the decreasing need for a certain type of weapon, and so we are working with that industrial sector, who have very important skills, which are not just relevant to complex weapons, and looking to encourage them to be using those skills in areas where we have a growing demand. I must say, from the maturity in the response in that particular sector, that is a sector where we have seen industry responding very well and I am optimistic that it is going to be possible for us to manage that process effectively. Nonetheless, we are going to see a decrease in requirement in that sector. To give you an example, a sector where we see an increase is in shipbuilding, the maritime sector. There the challenge is that we need to ensure that the way we manage the increase which is built upon the very strong shipbuilding warship orders which we have over the coming years does not create an unsustainable level of employment which is then going to go into a bust situation after boom. We have got many years to plan this well. Therefore, when you are in a situation like this where we can see increasing orders, increasing demand, we need to be intelligent about using that period to make sure that we are getting real efficiency into the industry and that we do not create an unsustainable level. Do you want to add anything to that?

Mr Gould: One point I want to add is that the nature of the defence industry is changing over time quite dramatically. There is a bit in the DIS that talks about the amount of defence activity that is open to the private sector. If you go back 30 years, it is really just the manufacture of defence goods, then you get into the services and now increasingly you find the private sector involved. For example, in military communications right from here in the UK up to day-to-day operations in Iraq the private sector is involved; so there is an expanding scope of work available to the private sector in defence which will enable us to build up. A lot of the companies involved in that, of course, will be involved both in defence and in civil because the technologies in communications and elsewhere are very similar and feeding off each other.

Q286 Mr Hancock: Can I ask Mr Gibson the role of the DTI in managing the change in those various sectors and where you fit into the matrix of change that is going to take place?

Mr Gibson: We fit in in the same way that we fit in for other sectors of British industry. Where there are large industrial closures - MG Rover is an example - we expect the RDAs to look closest to the ground to work with the local arms of other government departments - Jobcentre Plus, Learning and Skills Councils - to pull together packages which help the workers who very unfortunately lose their jobs to gain opportunities elsewhere.

Q287 Mr Hancock: Could I come back to you, Minister. You rightly raise the issue about the shipbuilding capacity, and the horizon looks very bright for the Type 45s and the carriers there, but, as you rightly say, we have to plan for what happens after that. With the way in which the ships are being designed now there is little chance of much of a follow-on to increase the number of surface ships the Navy will require. How do you envisage the MoD working with industry to prepare for that downturn that will come post 2014 or whatever the date is?

Lord Drayson: We have analysed the ship-building industry in this country and we can see that we have got companies and yards which are absolutely world-class - there is no doubt about it - and are able to go toe-to-toe against international competition and win. There are other areas where they are not as efficient as they need to be. When you look at the overall industry, it is clear that too much of the industry is represented by the MoD as a customer. What we want to see is that. by the changes which we encourage in the way in which we work with industry over the next ten years, we help the industry to become more internationally competitive, we see the spread of best practice throughout the industry, such that industry is able to win more orders from other customers apart from the MoD. What we have seen in the DIS is a focus towards a high value-added end of the ship-building industry. That is the area which we believe we can really compete in, the area of complex systems integration. I have visited yards and seen, for example, the Astute submarine build and you see the complexity of that vessel - it is more complex than the space shuttle and a lot more modern and it is British built - so there is no doubt that our industry can do this, but we need to get best practice throughout the industry and I think that then will provide us with a sustainable industry into the future, and that is what we are aiming to achieve. I think we have the time to do it. The key is the implementation of the Defence Industrial Strategy and the Maritime Industrial Strategy particularly through this year. 2006 is a very important year, because there are some important milestones on some of the projects which we are working on, not least of all Carrier. Carrier is going to be one of the ways in which we are going to help to encourage and drive this process, and I am very focused on making sure it really does happen, but I think the opportunity is there.

Q288 Chairman: Minister, I understand that when you were talking to the Defence Manufacturers Association last week you said, in effect, that you were "a man in a hurry". I hope that Mr Gould will keep his ears shut when I ask this question. Do you find that your officials are in as much of a hurry as you are?

Lord Drayson: I think they are getting there, Chairman, yes.

Q289 Chairman: You have also said that you recognise that the Ministry of Defence has got to change. In what respects do you think that the Ministry of Defence has got to change and how do you think those changes will be put into effect?

Lord Drayson: I think that the industry has to change and the MoD has to change - that is the point - but I think there is a duty on the MoD to demonstrate through its change that it is serious about the Defence Industrial Strategy being real. If I was in industry running one of the defence companies, I would be looking carefully to see how quickly the MoD is getting on with the things that it has promised to do. The way in which that is happening in the Department I am actually seriously encouraged by, and I aim to surprise this Committee, if you like, in the future by the pace of change which we are able to achieve in the Ministry of Defence. Why do I say that? Firstly, the way in which the MoD responded to the challenge of getting the Defence Industrial Strategy published in the timescale, the way in which it went about that, and the team of people that were responsible for it, I believe, did an absolutely outstanding job and I saw real excellence in the Civil Service which I think industry then responded to. We have set out a "to-do list" of changes and we have set timescales. The Permanent Secretary has put a small targeted team of people to look at the whole acquisition process, based upon what we have set out as principles in the DIS, and to report back by May on the changes which we need to make, building on the improvements that have been made to date. Things like Smart Acquisition, the series of improvements in procurement which have been achieved by this Department have been good, in my view. It is about building on that and going further. In June, Chairman, we should be seeing the outcome of that as one example. The impression I get within the Department is that it is the recognition of the changing environment, and it is the changing environment that we face, in terms of the threat of globalisation and increasing complexity of technology, which requires MoD to improve. Your Committee and other committees have said that when the MoD does things well it is a real gold standard. We need to make sure that that practice is spread more evenly, and there are some very clear things which we need to do to achieve that in terms of increasing things like commercial skills within the Department. The whole emphasis on tough commercial partnerships in the DIS requires the Department to have the people with the know-how to manage those types of relationships. We need to ensure that that happens. The way in which the Department tends to be very good at the urgent operational requirement, tight procurement process, very good indeed, but less good at some of the longer term projects means that we need to come up with processes which take the best out of the UOR process and apply them more effectively to the longer term projects. There is a whole list of things - a to-do list - which is set out in the DIS. The impression I get is that the Department is really up for this change. Both industry and the MoD recognise that we have an opportunity here to make a step-change in performance. The DIS has given us a good framework and an action plan to do that, and what I am seeing is that the Department is responding. The way in which I think we should be judged is in the quality of the decisions that we take and the difference we actually make to procurement. What I have said both to the Department and to industry is that 2005 is the year we came up with the Strategy, 2006 is the year that we seriously implement it to be able to show results both to your Committee, Chairman, and to others who scrutinise us, that we really have made a difference. When I say I am a man in a hurry, I am in a hurry to show in 2007 that this has made a real difference to our defence capability and the strength of our defence industry.

Q290 Chairman: You may have read that some witnesses in front of us have said that there was more information provided to the defence industry in the United States when the United States took some of its procurement decisions. The Ministry of Defence used to be more forthcoming in relation to its future intentions, its priorities and its plans. Do you think that that is a fair accusation? Is the Ministry of Defence planning to be more forthcoming in relation to its priorities and its plans?

Lord Drayson: Yes, it is. The DIS sets out explicitly a recognition that there needed to be more transparency because industry did not have enough clarity to be able to make the investment decisions which were going to drive the improvements which we needed to see. Without going into the historic reasons, I think it also reflects that the relationship between the MoD and industry was not as effective as it needs to be, and I think that the DIS has made a positive difference to that, and that is something which we need to build upon. We also need to be mindful that some of the things which the United States has done in terms of the release of information has had some negative consequences, and we were very mindful to learn from that. For example, I was very concerned to make sure that in going into the gritty detail which I promised in the Defence Industrial Strategy we did not make the mistake of providing such clarity over where we saw the really smart, young, innovative companies that we will provide a shopping list of acquisitions for bigger companies. We need to be careful. We do need to push the transparency issue consistent with our security interests, but also being intelligent about the global market place which we operate in and making sure that we do this in a way which helps companies provide solutions to our needs without actually making life more difficult for them.

Chairman: We are moving on to the issue of sovereignty.

Q291 Robert Key: Minister, I found one of the more intriguing chapters in your Defence Industrial Strategy B1 on Systems Engineering and I would like to ask you a little bit about appropriate sovereignty. Obviously, if we are going to retain sovereignty over a proportion of our production and systems, it is going to come at a price. Has the Government thought how much? What price? Whether it is a five per cent premium, a ten per cent premium, a 20 per cent premium. Can you give us a little more of your thinking on what you mean by appropriate sovereignty?

Lord Drayson: Yes. We did a thorough analysis of the defence market by sectors and we looked at it from the perspective of, in a particular sector were there defence capabilities which we regarded as being so strategically important to our defence interest and where we were concerned that not having those capabilities on shore may lead to others having an impact on the operational freedom so that we had to have that done here in the United Kingdom, and so we set that out. We have also said very clearly that we do have and want to have one of the most open defence markets in the world. Therefore, we are not concerned about where the shareholders owning these companies live, but we are concerned in certain areas where the intellectual property resides, where the design authority is held. What we have found, and this is why a section on systems engineering is so important, is that as defence equipment is moving in a direction where the actual platform, such as an aircraft or an armoured fighting vehicle, may be in service for a considerable length of time, decades in some cases, the subsystems - communications, sensors and so forth - which really deliver the advance military capability have a much shorter life cycle and therefore need to be upgraded much more frequently. We need to have the capability in this country to do that, which is why systems engineering skills are important in this country, it is why we need to have clarity when we go into a project - FRES is going to be an important example - that we know where the intellectual property is held and that we manage intellectual property linked to the delivery of freedom of operational capability. To answer to your question about price, we then rely on the market to operate on a basis whereby the competition within that - as I say, that balance of openness and encouragement of people to bring those resources and skills into the United Kingdom to deliver us the requirement at best value for money. I think the important thing, which I have not touched upon this morning, is that we have shifted our emphasis in the Defence Industrial Strategy to make value for money the bedrock of the whole thing away from a particular technique, such as competition, to saying that competition is one of the many tools which we will use and that is a recognition of the realities of the different markets and environments we have in the different sectors. For example, take the C4-ISTAR type sector - very healthy, lots of innovation, does not give you much intervention - and take another sector with much less competition, which does have a key strategic defence capability for us, we need to be much more clear about how much we manage that.

Q292 Robert Key: How does that relate to investment decisions of private companies? We have just heard from BAE Systems on explosives production, for example, that they do not believe they should be investing in low technology, and so they are not very interested in the Royal Ordnance factories at Bridgewater and Chorley, it seems. They do not mind if you cannot acquire ammunition from the United Kingdom. Are you happy with that? Does it fit in with your analysis?

Lord Drayson: I have looked at all of that very closely because it is very important that the UK retains the ability, in terms of advance munitions like that, to be able to source what it needs when it needs it, and I am satisfied that the changes which are being made, which are about coming up with a more efficient supply chain for the supply of these munitions by British Aerospace, does satisfy our needs. The key thing there is to be very clear in a manufacturing process, whether it is munitions or anything else, of where the really clever bit is and making sure that we have visibility of that clever bit, that we know where the skills are to do that, and, where those skills are important to our defence capability, such as they are in this particular case, that they are done in the United Kingdom. Do you want to add anything to that?

Mr Gould: Yes, several things. Certainly on the general munitions subject, it is difficult to distinguish between the raw materials, which have always been bought in. Even when things were being manufactured in Bridgewater and Chorley raw materials were being brought in from outside, quite a lot of the supply chain came from overseas. As I understand it, if you have got a secure supply chain of raw materials, so long as you can assemble and manufacture the munitions and have the capability to do that, then you are in control of your own destiny. That is the important point. I would just like to pick up on one point. Is there a premium for keeping things in the UK? I am not sure that there always is or has to be. I was thinking in particular of combat management systems in war ships and submarines. I cannot mention individual companies, but some of the companies who work for us doing that are very competitive internationally, and so, although we are keeping some of those skills in the UK, and need to (this is very important), the fact that they are competitive internationally tells me that maybe there is not a premium for that. Very often, if it is managed well, there does not have to be a premium, but we do need to work very closely with the companies to make sure that is the case.

Chairman: I will come back to you on that issue in just a second. David Borrow, is there anything you want to ask in relation to Bridgewater and Chorley or has the subject been covered?

Q293 Mr Borrow: I wanted to perhaps seek some more reassurance. I am aware that the closure of Bridgewater and Chorley will lead BAE Systems to purchase certain munitions from overseas, and they are currently looking at a number of companies. I have seen details of some of the companies overseas that they are looking to buy from. There is an argument around jobs, but there is a bigger issue around security of supply. Obviously, before we end UK production of some of those munitions and rely on overseas suppliers, the MoD will need to be absolutely certain that there is security of supply and that it is not possible for another government, at a time when we are involved in military operations, to stop us getting access to the munitions we need. I recognise that it is an issue around whereabouts in the technology tree we should be putting investment, but, irrespective of that, and that may be an issue for BAE Systems, as far as UK Plc and as far as UK Military are concerned we need to be certain that we can get access to the munitions that we need should we find ourselves in a situation of military conflict in any part of the world. At the moment those contracts have not been signed by BAE Systems, and I just want some assurance that the MoD are going to be absolutely sure that there is absolute certainty of security of supply before we allow those facilities at Bridgewater and Chorley to disappear.

Lord Drayson: That is absolutely central to our thinking. You are absolutely right. The DIS sets out this point about defence needs coming first. We are very mindful of this point, and that is what is guiding our thinking. We are not able to go into the detail of this process, but you need to recognise that there is a generational technology change taking place in these types of munitions which is going to require us to go to the next generation of process anyway. This is the opportunity to look at this process and to look at how we can make it more efficient but also making sure that we have got, as you say, absolute control over security of supply for the United Kingdom. The way in which this is being brought together, looking at the shift to manufacturing of certain elements in Glasgow(?), is consistent with the objective of making sure that we have maintained this capability.

Q294 Chairman: Can I double check something there. When Mike Turner was before us previously and he was asked about the closure of factories at Bridgewater and Chorley, the phrase he used was that they would want to be "fairly sure", but you would accept the phrase that has just been used by David Borrow, "absolutely sure" that we would have security of supply, would you?

Lord Drayson: Yes, absolutely sure, and absolutely sure not just in terms of the security of supply of the elements, as David has said. Often it is about the cleverness of the process. What I think we need to be absolutely sure about is what we do to the raw materials and how we bring these things together and what is done here. I want to be absolutely sure, in terms of security of supply of the elements coming in and I also want to be absolutely sure about the robustness of the manufacturing process that we are moving to, and I have spent quite a lot of time checking that.

Q295 Mr Hancock: How can you prevent that? How can you be absolutely sure if, as we were told by the boss of the operation, they are determined to close these plants? I am interested to know how you can insist upon this and be assured that you are going to get what you have asked for?

Lord Drayson: We are the customer.

Q296 Mr Hancock: Whilst the customer is always right, the customer does not always get what they want. We have been in that situation as a nation where we were dependent on certain elements of our weapons which were not delivered, which we were restricted from using, and our soldiers were seriously disadvantaged by it.

Lord Drayson: That is absolutely right.

Q297 Mr Hancock: I am interested to know how we can be absolutely sure of that now.

Lord Drayson: We are learning the lessons of the past, and it is very important for us as a nation to recognise that to get the defence capabilities we need in many cases we have to enter into international collaborations, because the nature of technology these days means you have to do that, but we also need to be mindful of the point, which you rightly raise, of avoiding getting into a position where in the future we are unable to use the defence equipment in the way in which we wish to use it because of restrictions which are being placed upon us, which is why we are thinking very intelligently, as set out in the DIS, differentiating between the different types of equipment and capability and making sure that we are taking decisions to deliver that defence capability. This is an example where we have got both a shift towards a different manufacturing process in a different location and a shift in terms of procurement of certain elements in that and we need to manage that very carefully indeed. There is no easy answer to this. The way in which you do it is by being very intelligent as a customer, being robust in terms of what you expect your suppliers to do and making sure that you have got these assurances in place and you check that they are in place as you go forward.

Q298 Mr Borrow: I can accept the situation that, if we were dealing with a small UK manufacturer of munitions who had decided that it was not economic to continue to produce those munitions, there is not a lot that the MoD can do, but in this situation we are talking about a special arrangement and agreement between the MoD and BAE Systems to supply the bulk of munitions. That is part of the Defence Industrial Strategy. They are in a sense the preferred customer. Therefore, if there are parts of that package of munitions which they currently produce which as a company they decide it is not economic to produce in the future, there is a strong obligation on them to satisfy the customer that they can still supply those munitions, with an absolute guarantee of supply, even if they as a company are not doing all the manufacturing. As I understand it, that is the key element of the DIS in relation to explosives and munitions, the fact that BAE are central to that role. Should they as a company decide not to do certain things, they have still got the obligation to deliver those munitions and explosives and guarantee absolutely that they will be supplied as and when required by our military personnel.

Mr Gould: We have had a partnering arrangement with Royal Ordnance for several years now in response to the very incident that Mr Hancock referred to earlier with the artillery ammunition. That has worked, on the whole, pretty well for us. Clearly, I could infer that it has not worked quite so well for the company in some areas, but you are absolutely right: in seeking to have a negotiation with a company that will continue that sort of long term arrangement, they must, as part of that deal, satisfy us that the supply chain they are putting in place does all the things that we require it to do. They must do it differently from the way it has been done in the past but they must satisfy us or we do not do the deal, we do something different. I am optimistic.

Mr Hancock: You might be interested to know in the letter that BAE Systems sent us today one of the companies that they put forward as one of the five is in the very country that caused us all the problems last time.

Q299 Robert Key: Hardly a day goes by without somebody talking, either in the Houses of Parliament or in the media, about the two-way street in defence procurement, particularly with the United States of America. I was delighted to see an interview with you at the time in February in which you said that the battle over technology transfer was your top priority for this year. How is it going, Minister?

Lord Drayson: I would say it is progressing reasonably well, but the test will be where we have got to at the end of this year, and the test will be the Joint Strike Fighter. We are working very hard indeed, I am working very hard indeed, on this issue because it is central to our defence needs, and I know that the Secretary of State is also working very hard, and throughout government. JSF is a project where we recognise the real benefits which the United Kingdom is gaining through working with the United States on this aircraft. However, we are also clear, as set out in our Defence Industrial Strategy, that being able to exercise the operational freedoms which we need over time with this aircraft is affected by technology transfer. Therefore, the reason it is my top priority is because we know that we need, by the end of this year, to have got clarity over certain elements of technology transfer which need to happen (and I need to stress) on a government to government basis to enable this to happen satisfactorily. I am optimistic that we can solve that. It is not a naive optimism, it is based upon the progress which I think we are seeing, but we are working very hard on it. I also think it indicates a general shift which is taking place within the defence industry, and which you have alluded to a bit already in your earlier question, which is the growing strategic importance of intellectual property to defence capability. Therefore, what I am looking to see happen, alongside the emphasis which we are placing on research and technology, is strategic management of intellectual property in procurement decisions up front in terms of clarity of the design authority, relationships with international partners and technology transfer, and that is something which we are actively working on this year, but I am expecting, frankly, for this to be resolved satisfactorily for us by the end of this year.

Q300 Chairman: Research and technology. The Defence Industrial Strategy accepts that more work needs to be done on this. What more work will be done and when will it be done by?

Lord Drayson: It will be done by the end of this year. The specific work which we are doing is to recognise that already the UK spends a lot of money (2.3 billion a year) on defence research - we are the second biggest spender on defence research - but we recognise that we can improve the performance of the value which we get from the defence research which we undertake and we will be publishing this year our Technology Strategy, which, as set out in the DIS, builds upon the work which we have already done. That is being led by Roy Anderson, the CSA within the MoD, and I think the important thing with research is for us to recognise the real linkage between delivery of defence capability and the research. We need to improve the performance in bringing through the outputs of research to making a difference to defence capability. In terms of my experience in managing research within industry, the key thing is that you are really intelligent about the investments that you make and you make sure that the innovation process is sufficiently fast moving and entrepreneurial such that it does get through to make a real difference to the front-line, to the defence capability, and we think there are some improvements which we can make on that. We are going to be publishing our Technology Strategy this year to address these issues and to look at the balance of where we are making our research spending. We are also opening up more research spending to competition as a way of encouraging that process.

Q301 Chairman: All the witnesses we have had this morning and earlier have talked about a decline in defence research and technology. John Chisholm this morning talked about a 50 per cent reduction and on page 39 of your Defence Industrial Strategy you talk about the highly significant correlation between equipment capability and R&T investment. What should the Government be spending in research and technology?

Lord Drayson: I like us to make decisions based upon data, and this study which you allude to on page 39 was funded by the Ministry of Defence, carried out for us, to really get a handle on how does research spend have an impact on defence capability, and it is now clear for us. What we have said in the DIS is that what we are going to be prioritising this year is more emphasis on excellence. What I learnt in terms of managing research is being very clear where you do research which is really world-class.

Q302 Chairman: Can I bring you back to the decline that we have had. Do you think we should have a higher level of spending on defence and research?

Lord Drayson: That is one of the things which we are going to be addressing this year, and so I think we need to see the result of the Technology Strategy that come out of it. What we see is that there is a real correlation between how much we spend and the defence capability which we get. I think there is an important correlation also in terms of the effectiveness of what it is we spend. My belief is, first, you fix your effectiveness. Before you start thinking about whether you are going to spend more money, you make sure that the money you are spending you are spending wisely, and that is something we are focused on as our number one priority. Secondly, we need to look at the balance of the defence budget in terms of investment on research and investment on equipment acquisition, and we need to ask ourselves the question of whether we have got that right. Our current policy is that we will be increasing our defence research spending in line with inflation. Up to now it has broadly been kept at the same level. We have increased that by saying that we are going to increase it in line with inflation. We need to look at whether we have got that balance right. This year the emphasis is on making sure that the way in which we spend the current research pounds is as effective as we can make it, and that is the priority that the CSA has.

Q303 Mr Hancock: You talked about effectiveness. It was suggested earlier that maybe one way of making the R&T spend perhaps go further or be more effective is to integrate it into some form of reinvention of demonstrator projects as part of the derisking activity of overall projects. Is that part of the thinking?

Lord Drayson: Yes, that is part of it, making sure that we use opportunities to build prototypes and we learn from doing that. In certain areas the pace of change of technology and research is very directly correlated to the military capability which we need right now. There is in some areas a real urgency. We are looking at areas to speed up this process. Some really innovative things have happened in the way in which we have restructured the defence research. The split of the Defence science and technology laboratories with QinetiQ was a response to the increasing importance of civilian research technologies into Defence. That has really worked well. We have now got a world-class business in QinetiQ. We have still got the DST labs doing the work which we need to do on the most secret projects, but we are focused within the MoD on making sure that there are not areas for us to go further in getting more bang out of the money we spend on research today.

Mr Gould: I wanted to say that the correlation as shown in the diagram is quite interesting because it flattens out quite dramatically at the top. It is not a problem for us at the moment but it does indicate that effectiveness really does matter in research, because you can spend a lot on research and actually not get very much benefit at a later stage. There are quite a few demonstrator programmes that do still go on in the research programme related to specific projects that are coming through in the future.

Q304 John Smith: What about the development of centres of excellence in military research and technology. Is there any early thinking on that?

Lord Drayson: They definitely work. That is a model which has been used very successfully in the pharmaceutical industry. Centres of excellence are definitely working for us. It is an example of a new approach to the management of R&D which is giving benefits, but we cannot stop there. There is more that we can do to improve the effectiveness of our research and the speed at which it is brought through to deliver military capability. That is the focus that we have got.

Q305 Mr Hancock: I am interested in the concept, which you emphasised quite a lot when you were last giving evidence, of proper risk analysis going on and how that is going to be funded. I sense that we will be spending a lot more on that to get it right and not so much on the research and development, because we are not developing new technology so much because you are not going to be putting the money up front into it. We heard from John Chisholm today that he expects you to be the main funders of that research. I was hoping he would say that the commercial world would be inclined to invest more in the research side, but he declined that and felt it was still the role of the MoD. Does it not lead you then to look for off-the-shelf solutions from outside the UK rather than to spend a lot of money on the risk evaluation of a product and a lot of money on research and development; so you simply buy a tried and tested product that might not have the full capability but is as near as you can get to what you want?

Lord Drayson: If the product which we want is available off the shelf, then we must use it. I think that is the lowest risk way of delivering the capability that we need. We need to recognise that increasingly there is much more interplay between defence research and civilian research than there ever was ten, 15 years ago, and we need to be more intelligent about exploiting that for our benefit. An example of us doing that in the DIS was our announcement about the UAV's project. There is an example, I think, where there is an absolute overlap. There are going to be real opportunities for unmanned vehicles in the civilian area and definitely for us in the military area. We have given clarity to industry of what our defence capabilities are, and we want to encourage people to come into that, see that as a commercial opportunity, so that young engineers, businessmen looking at start-ups say, "Right, there is a real potential market opportunity here meeting the defence needs." It is about us then encouraging the way in which that is done, and I have seen really good examples of entrepreneurial, smart thinking in terms of research, particularly in response to the UAVs, and so I think this is an area which we are building on quite effectively.

Mr Gibson: We are actually increasing our funding of civil aerospace R&D. There was a report by the Aerospace Innovation Growth Team in June 2003 which asked us to increase the level of funding to 75 million a year, and we are largely achieving that and we are doing it in a lot of innovative ways. The Minister mentioned UAVs. We are funding a UAV project on a commercial side, the DTI is putting in about five million a year and the Regional Development Agencies are putting in about 11 million a year, matched in both cases by industry. We would be delighted if there were spillovers from that civil project into the defence side. To the extent that we are increasing our government funding on the civil side and that there are spillovers to defence, we see as entirely positive.

Q306 Mr Hancock: I was just going to ask a question on the performance measures you were going to implement to judge how you were successful or otherwise on the DIS in both organisations?

Lord Drayson: From the MoD's point of view.

Q307 Mr Hancock: I know what you said you wanted to achieve, Minister, but I would be interested to see if the MoD had set themselves some targets for a change in their mentality?

Mr Gould: Our ultimate measure will be our success in providing equipment capability into the Armed Forces. If we see improvement in the way in which projects are planned, conducted, executed and the speed with which the capability is introduced into the system and then put on to the battlefield and used, or hopefully not used, but used in a deterrent sense by the Armed Forces, then that is the ultimate measure of success and every single project that we undertake is measured in great detail in those terms.

Chairman: Moving on to partnering arrangements.

Q308 Mr Borrow: Fairly briefly, because we have touched on the issue about partnering arrangements earlier. One of the issues that has been raised with us, and we have had evidence in previous hearing about it, is a suggestion that because BAE Systems, in particular, have such a dominant role in the partnership arrangements under the DIS there is a risk that they could become a monopoly supplier. Would that be in the long-term interests of the MoD or are there are dangers in that in terms of getting value for money in view of the lack of competition in that area? I understand the dilemma, but can you explore that a little bit?

Lord Drayson: I think, first of all, that it is excellent that we have in BAE a global player within the defence industry, one that really can go toe to toe against the best in the world and win. That is very importantly positive for the UK defence interest. Secondly, I think we need to look at the data. The reality is that five per cent of the MoD's defence contracts per year go to BAE. That is the fact.

Q309 John Smith: Is that by value?

Lord Drayson: Yes, by value. Direct defence contracts to BAE from the MoD, if you look at the last two years, five per cent. If you look at BAE's customers, the MoD represents 28 per cent of their turnover. I recognise people's concern about this, but I would say the boot is on the other foot a bit. We are a very important customer to BAE, but we need to recognise that in a number of important areas for us BAE is the design authority - if you look at the number of our armoured vehicles, for example - and, therefore, what the DIS does is face up to the reality, which is that we are in a mutual dependence with BAE in some very important areas for us and we need to manage that with the appropriate management tools to get value for money for the British taxpayer. It is about tough partnership. It is about BAE delivering improved performance in return for longer term business with us. I think that the way in which we are moving with BAE is very positive for the British interest and the defence taxpayer value for money point of view.

Q310 John Smith: But how, Minister, do you incentivise a sole monopoly supplier to maintain best practice and continue to be efficient if there is no alternative capability in the long-term? How do you do it?

Lord Drayson: Firstly, you only enter into those types of arrangements if those are the realities of the market you are operating in. If you have got a market which allows you to have a competition, then competition is the right tool. In certain circumstances where you do have de facto a monopoly supplier, you need to manage it to respond to that. The way in which you do that is to enter into longer term contracts where the payments to the company are linked to improvements in performance. What you do is make a direct correlation between their profit and their improved performance over time through a sustained relationship and you make the metrics of the relationship really clear. You build the contract around that. What you have to have within the MoD are people with the skills to be able to write and manage those types of long-term relationships. I know from my own personal experience industry is used to these types of relationship. For example, many companies partner their IT systems because they recognise they are not the world's experts in IT, and they enter into a recognition of long-term relationships with companies to do that. For the MoD to make a success, we need to get really competent and professional, actually excellent, in the way in which we manage these types of long-term partnerships. An important pilot for us, if you like, the first one we are doing, is with Augusta Westland on certain types of helicopter. That is another example of where we have this de facto relationship on a whole fleet of helicopters which we are already using. It is very important for us to manage that long-term relationship with Augusta Westland on the maintenance and sustainment of that fleet.

Q311 John Smith: A leading defence industrialist earlier today told us that he thought competition had been a disaster for the UK defence industry. Do you share that view?

Lord Drayson: No, I do not think it has been a disaster. The way I look upon it is that the defence industry is not homogenous. The different sectors within the defence industry exhibit very different market characteristics. Therefore the MoD needs to be sophisticated. It needs to use competition, where competition is the right tool, to get the best value for money for the taxpayer and, where competition is not the right tool (and we have seen some instances where it has been used in a way which has not produced a good outcome), that we do not use it. For example, on Carrier, because we need a number of different companies coming together to build these enormous carriers we needed to form an alliance, and we need to make sure that the way in which that alliance is formed fits the realities of the market. I do not think it has been a disaster but I think we have got more intelligent at picking up the right tool for the job and using it in the particular circumstances of the particular project in the particular sector.

Q312 Robert Key: How does the Government see the European Defence Agency developing?

Lord Drayson: It should learn to walk before it runs. It needs to show that it can really add value. We think that there are some ways in which it is beginning to show that, but our view is that it should start small, have some successes and then grow.

Q313 Robert Key: Are there other implications for the wider international defence industry here that you can have? We have been told by some of our witnesses, for example, that they feel not enough attention has been given to the international dimension of the Defence Industrial Strategy?

Lord Drayson: The feedback that I have had from our international partners has been very positive about that. They have found it useful to have clarity, whether it is in the direction of the United States or the direction of Europe. One positive example of the EDA is the way in which the code of conduct has been established for other nations, which is aiming to encourage other nations to be as open as we are in some of their defence procurements. We have set out principles pretty clearly in the DIS as to the way in which we want to do business with our international partners - clarity and sovereignty, and so forth. We think that is a positive start.

Q314 Mr Havard: We did have some questions, one of which is a bit mischievous, about how you might get more money from the Treasury, but if you can spend the money you have got more effectively that is a good start. I was interested in what you have said about how you are going to deal with these things. Quite clearly the Strategy as we have it is the overview. There are clearly a number of strategies within different working groups and different things that you have spoken about already. You have talked about the technology review coming towards the end of the year. I think you have talked about some work being done about process that might report in June. I cannot remember whether you have set a date for the Maritime Industrial Strategy, and so on. Can you give us an idea, because you have been described by some as having gone through the model like a whirlwind so far - that is what has been said about you. What is the pace at which we are going to see these sector analyses and programmes so that we can have an idea of what is coming when and how we can also judge what we need to do in terms of how we can continue to scrutinise the process?

Lord Drayson: I have two sides of A4, Mr Havard, which is my check-list of the to-do list of things which we had promised within the DIS would be achieved, and I am very happy to be held accountable for us achieving those. We have identified within the Ministry of Defence specific people with accountability for delivering them to me. I have set out a ministerial direction to the MoD that decisions must be taken consistent with the DIS, and if we are looking at taking a decision which is not consistent with the DIS, I want to know about it. I think that we have set out our target dates - we mention May - for having clarity about the changes that we need to make in terms of our acquisition processes, we have set about a technology strategy which we are doing this year, I want to see the maritime industrial strategies implemented in 2006. It is very important for some of the big projects which we have got. We have got a clear to-do list which I am monitoring very closely indeed.

Chairman: Two sides of A4. We like that.

Q315 Mr Havard: Is it possible we could have visibility of this?

Lord Drayson: You are very welcome to have both sides.

Q316 Mr Havard: It is quite clear you have got a momentum, and the tempo is important in terms of war fighting and in terms of rugby and so I am looking to learn lessons for other purposes!

Lord Drayson: I would be happy, Chairman, to share the list.

Chairman: Thank you very much. That would be extremely helpful. You have come in before one o'clock, which is another significant achievement. Thank you very much indeed, to all three of you, for your evidence and to the Committee for your questions.