- Defence's procurement of six Evolved Cape Class Patrol Boats
Auditor-General Report No. 15 2021–22
Introduction
Background
6.1In April 2020, the Department of Defence (Defence) contracted with Austal Ships Pty Ltd (Austal), an Australian shipbuilding company, for the construction of six new Evolved Cape Class Patrol Boats (ECCPBs). The decision to purchase the vessels followed the receipt of an unsolicited proposal from Austal to build new ships rather than extend the service lifetime of Defence’s existing Armidale class ships.
6.2The objective of the audit by the Australian National Audit Office (ANAO) was to assess the effectiveness of Defence's procurement of the six evolved Cape class patrol boats.
Audit findings
6.3Auditor-General Report No. 15 2021–22 Department of Defence’s Procurement of Six Evolved Cape Class Patrol Boats found that the procurement of the Cape class patrol boats was largely effective. Its decision making and advice to government were effective, and it implemented largely appropriate contracting, governance and reporting arrangements.
6.4The report made one recommendation to Defence which related to its management of probity. Defence agreed to the recommendation.
Chapter overview
6.5This chapter considers the ANAO's findings with respect to the acquisition of the ECCPBs and Defence's actions taken in response to the audit. In particular, it considers:
- Defence's receipt and consideration of Austal's unsolicited proposal
- the probity arrangements Defence put in place for the project, and
- Defence's contract management and delivery arrangements.
Procurement decision making
Receipt and consideration of the proposal
6.6The framework under which Defence conducts is procurements differs slightly from that at other Commonwealth entities. Procurement at Defence is undertaken in line with the Defence Procurement Policy Manual (the DPPM):
The DPPM incorporates both the Commonwealth Procurement Rules (CPRs) and additional Defence Procurement Policy Directives that must be complied with by Defence officials in relation to procurement. Defence Procurement Policy Directives supplement specific the CPRs in the context of Defence's particular circumstances and needs.
6.7On 5 September 2019, Austal provided Defence with an unsolicited proposal for the lease of six Cape Class Patrol Boats.
6.8Prior to the receipt of the proposal, Defence had planned to develop a life-of-type extension (LOTE) for its current fleet of Armidale Class Patrol Boats by way of transitioning to the planned Arafura Class Offshore Patrol Vessesl (OPVs). Under the original plan Defence also intended to extend the existing lease of two Cape Class Patrol Boats to support the transition to the OPVs.
6.9Austal's proposal presented Defence with an alternative transition arrangement. In April 2020, Defence sought government approval to acquire six ECCPBs and discontinue the Armidale class LOTE. Government approved the request, and soon after a contract worth $356 million was signed for the construction of the six ECCPBs.
6.10After receiving the offer, and being aware of Austal's advice to the government that unless it received more work from Defence it would be forced to make part of its Australian workforce redundant, Defence considered the proposal to be 'live'. It was presented to the Chief of Navy Senior Advisory Committee on 4 October 2019.
6.11Defence wrote to Austal in on 21 October 2019 to advise that the proposal was 'of genuine interest' to Defence. Austal was then sole sourced to undertake a Risk Reduction Design Study, which was intended to:
identify all deviations from the extant Cape class patrol boat design, provide impact assessments of those deviations, develop ship design documents including system specifications, and develop lifecycle upkeep and sustainment intelligence system specifications. These deviations included modifications to the extant design to address known deficiencies in the extant Cape class design which had previously resulted in sustainment issues.
6.12Following this and based on the results of the Risk Reduction Design Study, Defence began a Collaborative Design Process with Austal to develop to project, and on 9April 2020 a request for tender was issued solely to Austal for the procurement of six ECCPBs and associated supplies.
Defence’s assessment of the proposal
6.13The audit found that 'Defence’s assessment of value for money of Austal’s sole source tender was largely appropriate'. The DPPM sets out conditions Defence officials should consider when determining value for money in a procurement:
Division 1 provides a framework for determining ‘value for money’. Under this framework, procurements should: encourage competition and be non-discriminatory; use public resources in an efficient, effective, economical and ethical manner that is not inconsistent with the policies of the Commonwealth; facilitate accountable and transparent decision making; encourage appropriate engagement with risk; and be commensurate with the scale and scope of the business requirement.
6.14Defence conducted its initial value for money assessment in January and February 2020. The assessment was limited to an initial assessment of financial costs and benefits. In April 2020 the Tender Evaluation Board conducted a deeper value for money assessment that considered a range of non-financial factors. The assessment relied on benchmarking rather than market testing and compared Austal's proposal with the existing Armidale Class LOTE project, reaching a final conclusion that the Austal proposal would save approximately $50 million.
6.15The Defence submission emphasises the expertise that it brought to these assessments:
In the case of the ECCPB procurement, Defence applied extensive knowledge, rigour and experience in assessing the unsolicited proposal, and determining the capability benefits that could cost effectively be derived from expanding Navy’s existing fleet of Cape class patrol boats (CCPB) rather than extending the life of aging Armidale class patrol boats (Navy operated two leased CCPB at the time).
6.16The ANAO noted that the Commonwealth procurement framework has made provisions for unsolicited proposals for quite some time, especially in the context of Defence procurements:
the unsolicited proposals concept has been in the Commonwealth procurement framework and the Commonwealth procurement rules for some time. We were looking specifically at the 2020 CPRs, which were the ones applying at the time. It is a longstanding feature of the framework ... Finance does, as a policy owner, have a responsibility for providing whole-of-government guidance in this space, and it has done so, because the whole notion of unsolicited proposals is something that the sector as a whole has to grapple with, and certainly defence has to grapple with it because there are some very active players.
6.17In relation to the treatment of unsolicited proposals, the audit report noted that the guidance material provided by the Department of Finance to assist agencies in appropriately treating such a proposal was inaccurate. The audit report noted that with regard to unsolicited proposals, the guidance stated that:
The Department of Defence receives many ‘unsolicited proposals’ from industry due to its unique business requirements. These proposals may range from small, off-the-shelf supply items to more complex capability solutions. Defence has therefore established an Unsolicited Proposals Gateway to provide a single entry point for businesses and individuals to submit their proposals to Defence.
6.18However, at the time of the audit, the Unsolicited Proposals Gateway referred to in the Finance guidance was no longer available.
6.19Dr Tom Ioannou, Group Executive Director, Performance Audit Services Group at the ANAO told the Committee that:
What we observed ... was in fact some of the guidance that Finance had put out at a whole-of-government level and some specific defence guidance was more or less out of date. So there is a question to be asked of Finance about its ability to keep important guidance up to date.
6.20When asked about the guidance it provides to procuring entities, the Department of Finance told the Committee that the review of its guidance is ‘an ongoing process that is generally triggered by changes in the legislative and policy environment in which Commonwealth entities and officials operate’:
The last comprehensive review of the procurement guidance was undertaken in 2020. Another full review of the guidance material is currently underway. Entities have been contributing to that review since June 2022. This review is in addition to updates made to specific guidance as required, in view of such triggers as those identified above.
Defence’s management of probity
6.21Defence did not consider probity risks upon receipt of the initial proposal in September 2019, but did so when it commenced negotiations with Austal in February2020, a delay of five months.
6.22The Auditor-General told the Committee that probity should be a key consideration in the context of unsolicited proposals:
The nature of unsolicited proposals probably heightens some of the issues around how you manage probity, which is why we raised the issues, particularly early on in the process of developing up a proposal. That's because the nature of an unsolicited proposal is that it hasn't been developed by the entity and there's not a competitive process within it. So getting to a probity early in those types of projects is quite core, we would say, in making sure you retain confidence.
6.23The audit report noted that Defence engages with Austal on a routine basis and on a wide range of matters. It went on to argue that:
While the ANAO did not identify direct evidence of joint development of the unsolicited proposal before it was formally received by Defence in September 2019, and Defence has advised that joint development did not occur, in such circumstances care needs to be taken to avoid the perception of joint development of a proposal which may result in procurement action, so as to avoid any perception that potential suppliers enjoy an unfair advantage.
6.24In this context the ANAO found that it would have been 'prudent' for Defence to consider probity issues earlier, so that any perception that it had developed the unsolicited proposal jointly with Austal could be avoided.
6.25As such the report recommended that Defence 'develop and implement specific requirements for the management of probity when engaging with industry on unsolicited proposals including by identifying, assessing and managing probity risk at an early stage, when considering and assessing the feasibility of unsolicited proposals.
6.26In response, the Defence submission stated that, while agreeing with the recommendation, its view is that its officials acted with probity throughout the procurement:
While Defence maintains that probity was managed effectively in this case, Defence has agreed to this ANAO recommendation and has responsibly implemented change through development and implementation of specific requirements for the management of probity in regard to unsolicited proposals. This has been reflected in strengthened arrangements within the Defence Commercial Framework and Defence Procurement Manual.
6.27Further, Rear Admiral Wendy Malcolm told the Committee that Defence had existing arrangements with Austal as a known supplier, and that these arrangements were satisfactory from a probity standpoint:
From our perspective, we felt that the arrangements that we had in the workplace that surrounded the current sustainment business with this particular company were well understood, and we certainly dealt with the unsolicited proposal seriously in considering probity, but we hadn't actually put a formal probity plan around this particular unsolicited proposal in place, as was certainly pointed out by the audit. So, from my perspective, I felt that the arrangements that were in place and the conduct of the officials were appropriate and complied with our defence procurement rules.
6.28Rear Admiral Malcom emphasised that Defence nevertheless agreed to the ANAO’s recommendation:
We understand the importance of what the audit report showed to us and so we recognise that we could have improved the way that we did those things and have acted accordingly. I don't want to suggest that I don't feel that way. It certainly was an appropriate recommendation. We believe that we have made the necessary policy changes and done the administration to reflect that.
6.29In relation to the specific measures Defence has taken to implement the ANAO’s recommendation, Rear Admiral Malcom said:
What has been put in place is that the procurement manual has been updated. In particular, we've developed and strengthened arrangements within the Defence commercial framework through the Defence procurement manual. We've updated policies specifically around unsolicited proposals and how they're dealt with, and we've provided stronger guidance on how those probity arrangements should be put in place pretty much as soon as there's an unsolicited proposal.
Contract management and delivery
Contracting arrangements
6.30The audit found that the contracting arrangements for the acquisition of the vessels implemented by Defence was fit for purpose:
Defence’s contract with Austal includes 20 milestones, with clear entry and exit criteria and due dates. Contract payments are tied to the achievement of milestones. Payment amounts are appropriately distributed to incentivise satisfactory contractor performance, with amounts held over until achievement of acceptance milestones. Performance expectations are clearly set out in the contracted statement of work, with additional detail about consequences for poor performance included in the conditions of contract. Provisions for corrective action are included in the contract, as are provisions for the payment of liquidated damages.
6.31In its submission, Defence pointed to its contracting arrangements, noting their contribution to the procurement achieving good value for money outcomes:
Defence established fit-for-purpose contracting arrangements for the ECCPB. This included contract payments being tied to the achievement of milestones and milestones being appropriately distributed with clear entry and exit requirements. The enforcement of these contract provisions by Defence, through strong contract management, has contributed to the achievement of outcomes and value for money for Defence.
6.32Defence also noted that it has a range of tools available for its officials to assist them in their contract management:
Defence’s contract management is underpinned by the Defence Contract Management Framework, developed to provide best practice guidance for the management of procurement contracts and to improve contract management outcomes for Defence. This incorporates a variety of contract management templates and checklists assisting contract managers when undertaking key contract activities.
6.33The audit report noted that as at December 2021, the contract with Austal had been subject to six variations by way of contract change proposals (CCPs). None of the CCPs had impacted the cost of the contract. The variations approved by Defence concerned matters including the reallocation of the Australian Industry Content (AIC) plan approval to a later milestone, and the incorporation of the AIC plan into the contract.
6.34AusTender records showed one variation in cost of just under $750,000 which corrected a financial reporting error in the purchase order but which did not substantively change the value of the contract..
6.35Defence argued that its focus on sound contract management frameworks and practices had paved the way for good outcomes in relation to the acquisition of the ECCPBs:
Since the ANAO report was published, Defence has accepted the three ECCPB and Austal and Defence have worked collaboratively to ensure delays due to Covid-related border closures and issues with aluminium quality have been minimised.
Governance arrangements
6.36The audit reported positive findings in relation to Defence’s governance and assurance arrangements relating to the ECCPB project:
The governance, oversight and coordination arrangements for the project include a combination of project-specific governance and oversight groups, as well as higher-level oversight and coordination arrangements for Defence’s naval shipbuilding activity as a whole ...Defence has recognised the risk and complexity of these non-standard administrative arrangements, with the anticipated benefits expected to outweigh the risk.
6.37However, the audit also noted that the full suite of assurance activities ordinarily undertaken by Defence had not yet been recorded at the time of the audit:
Two mandated governance documents - the Product Delivery Agreement (Materiel Acquisition Agreement) and Integrated Project Management Plan - had not been approved as at 1 December 2021, and no independent assurance reviews have been conducted to date. As a consequence, Defence and its senior leaders have not had the benefit of the full suite of inputs which contribute to providing assurance that capability requirements are being successfully delivered by an acquisition project.
6.38A risk management plan for the project was approved in April 2021. According to Defence, three internal risk meetings had been held since the contract was signed in April 2020 two of which predated the risk plan. In addition:
As part of the acquisition contract, Austal has produced and delivered a description of its risk management processes and procedures within its Project Management Plan, and has maintained a risk register for the duration of the contract. Records indicate that risks and issues were regularly discussed at Progress Review Meetings between Defence and Austal.
6.39The contract is monitored through regular Contract Status Reports from Austal to Defence which provide information on progress, planned activities, and risks. A Contract Master Schedule was approved in July 2020. Updates submitted by Austal must be approved by Defence. Austal also provides reporting on progress against Defence's Australian Industry Content plan.
6.40The audit found that Defence’s activities to manage project milestones have been appropriate, although delays of 26 to 35 weeks were reported to allow rectification work following the use of defective aluminium and production workforce inefficiencies.
6.41Of the 12 milestones which were at the time of the audit, Austal had claimed eight. Four of the eight were claimed on schedule, with two further being claimed within two weeks of the scheduled date. Delays in the construction of the first boats is expected to flow through to the later vessels.
6.42The ANAO found evidence that Defence had raised the issue with Austal, and that Defence had appropriately revised its Patrol Force Capability Transition plan in July 2021 to delay the retirement of the Armidale class boats which remained in service. Audit.
Committee comment
6.43The Committee is pleased to note the generally favourable findings of this audit report, which stand in quite stark contrast to the other audit reports that make up this inquiry. In particular, it is commendable that Defence conducted a rigorous and well‑documented value for money assessment in response to an unsolicited proposal from Austal. Sole sourced procurements require value for money to be established without the benefit of competition, requiring entities to make informed judgements as to cost and capability, benchmark them appropriately and retain proper documentation of its processes in line with the procurement’s scope, cost and risk.
6.44The Committee notes the ANAO's finding that elements of Finance's guidance to procuring entities relating to unsolicited proposals contained references to a resource that no longer existed at the time of the audit. Notwithstanding the otherwise positive findings of the audit, the Committee considers that Finance should verify that this and the remainder of its procurement guidance materials have been made current as part of the review of its guidance material that it is currently undertaking.
6.45The Committee recommends that the Department of Finance report back to the Committee within six months of the tabling of this report with the outcomes of its review of its Commonwealth procurement guidance, including a list of changes made to the guidance as a result of the review.
6.46The Committee does not have any recommendations relating to Defence’s acquisition of the ECCPBs and extends its thanks to and commends Defence for its cooperation with this inquiry.