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Chapter 14 - The role of defence in Australia's Naval shipbuilding and repair industry-informing industry
Background
14.1
Information is the lifeblood of any industry. One way of improving the
efficiency and overall performance of an industry is to ensure that it has the
necessary information to learn from previous experiences and to plan ahead. This
chapter focuses on how well the Australian industry is informed about the
performance of past projects, including local premiums, and about Defence's
policy on Australian involvement in major projects. It also considers the value
of the Defence Capability Plan as a means of keeping the industry informed
about Defence's future plans and intentions regarding its acquisition program.
Australian industry—an informed provider
14.2
As noted in chapters 9 and 10, the committee was unable to obtain any
meaningful data on the productivity of Australia's naval shipbuilding and
repair industry. Furthermore, recent studies conducted on Australia's naval
shipbuilding projects by ACIL Tasman, commissioned by the Australian Industry
Group Defence Council with support from other organisations and the Department
of Defence, had difficulty extracting information from the department.
14.3
In a general discussion about the availability of information on major
naval products, Mr John O'Callaghan, Head of the Australian Industry Group
Defence Council, told the committee that, for example, he had never seen any
public analysis of the problems that occurred with the Collins class submarine.
He said:
I know for a fact that one of the great errors we made, and I
was partly responsible for it, was that we paid too much upfront at the time we
signed the contract. That meant that when we got downstream we did not have
enough financial leverage on the contractors—because that was more than one—to
force them to perform better. That was an important lesson. That is the sort of
lesson I am talking about.[1]
14.4
Mr O'Callaghan acknowledged that problems are a natural part of project
activity but 'it is how those problems are managed which is the key thing'. He thought
that Defence needed to be 'a bit more mature about putting on the table' some
of the lessons from experiences such as the problems with the modernisation of
the FFGs and the Collins class submarine. In his view, such an approach may
help industry avoid the sorts of problems that have arisen. He said that he had
never seen any public analysis of these problems and called for a 'sensible
debate' about failures:
...exposing some of these analyses so that industry can get the
benefit of it, and the media, would avoid some of the tabloid sensationalism
that we see from time to time.[2]
He added that one of the challenges for the DMO over the
coming five years 'is to fess up when errors are made because we learn from the
errors'.[3]
14.5
A number of commentators pointed to the problems that can result from
the lack of information about Navy acquisitions including the speculation that
can swirl about a project when information is vague or general.[4]
Mr Derek Woolner noted:
Had people understood that the Collins submarine project was a developmental
project and that there had been a change from the earlier stated project
objective, which was to buy a proven submarine in service or about to enter
service with an overseas navy, there would have been a greater understanding of
how the project would work out, perhaps some expectation that there would be
problems that would need to be fixed and a clearer basis on which to draw the
contract.[5]
14.6
The lack of data on the public record means that industry experts and
companies involved in the industry cannot obtain a complete picture of how the
industry operates. On the one hand, insufficient information stifles public
debate and undermines accountability and on the other encourages speculation
about projects. Such a situation is unhelpful for the industry and for Defence.
14.7
Commercial-in-confidence concerns may well prevent some information from
being available. Even so, regular and frank analysis of the successes and
failures of projects and the extent of assistance given to a project (local
premium) could assist industry. This knowledge would help to keep industry
better informed about the performance of particular projects and also make
Defence more accountable for its decisions and the way it manages major
projects. Indeed, as noted earlier, Mr John O'Callaghan, Head of the Australian
Industry Group Defence Council, was of the view, that a more open approach may
help industry avoid the sorts of problems that have arisen.
14.8
The committee sees a need for Defence to make available information that
would enable the analysis of major projects and to release the results of their
own studies on the performance of projects. In noting that the studies that
have been undertaken on major naval acquisitions tend to be conducted at the
end of the construction of the vessels, the committee suggests that data should
be gathered and analysed as a project moves through its various construction
stages. This continuous monitoring would increase transparency and improve
accountability of how a project is being managed. Clearly, Defence, must
develop and adhere to high standards of probity and accountability in its
procurement practices. The committee accepts that commercial-in-confidence
requirements will prevent the disclosure of some information but this should
not be used as an excuse for withholding data that could be placed on the
public record.
Recommendation 2
14.9
The Committee recommends that the government establish a thorough
detailed model, subject to audit by a body such as the ANAO, for the
establishment of through life design, construction and maintenance costs of
each naval ship building project in the future by class and by individual ship.
The model to contain sufficient detail to enable benchmarking to be done on an
international basis, providing total budget accountability, assessment of domestic
industry competitiveness, including all administrative overheads, with industry
compliance to be mandated in all contracts.
14.10
The committee recommends further that Defence commission an independent
assessment of the progress of major projects against the model as it attains
set milestones providing explanations for any departures from the costings and
other projections contained in the model. The reports to be provided to the
Minister for Defence to be tabled within 3 months of being submitted to the Minister.
14.11
The committee now examines local build premiums as an indication of the
information made available on naval acquisitions.
Premiums for local builds
14.12
As mentioned in chapters 3 and 4, Defence has awarded local industry a cost
premium for past RAN warship projects. It is very difficult, however, to obtain
reliable evidence on the premiums. Even for well-publicised projects such as
the ANZAC Ship Project, the committee cannot confirm the veracity of the 3.5
per cent figure.
14.13
This confusion also surrounds the upcoming LHD bid. Mr O'Callaghan drew
the committee's attention to an article in the Australian Financial Review
on 29 July 2005 which stated estimates that an in-country build of the LHDs 'could
be 30 per cent higher than the cost of acquiring them overseas'. Mr O'Callaghan
rejected this estimate stating:
It is a number which to the best of
my knowledge, no-one in Defence has ever exposed with any analysis. It is a
number which has no bearing in terms of our own track record in the Australian
defence naval construction industry in successfully building the number of
platforms I mentioned previously.[6]
14.14
Again, the lack of clear statements by Defence has encouraged public
speculation. Mr O'Callaghan stated that Australian industry has never had 'the
benefit of the sort of modelling or analysis that is being done within Defence
and which leads to that outrageous ‘30 per cent’ statement being made...' He
added 'It is bunkum, basically. I would love to see the analysis, so let us
encourage them.'[7]
14.15
Engineers Australia suggested that Defence should provide clear guidance
on the level of any premium attributable to construction in Australia, versus
construction overseas, and particularly for the costs of any new infrastructure
and training of personnel.[8]
14.16
It should be noted that, according to Defence, it 'does not directly
apply a premium to undertake naval shipbuilding projects in Australia'.[9]
It explained:
In accordance with Commonwealth Procurement Guidelines, the
source selection for the acquisition and sustainment of military platforms and
systems is based on best value for money. The strategic value of generating and
sustaining indigenous industry capabilities, as required in support of ADF
operational capability and military self-reliance, is one of many factors taken
into consideration in Defence’s overall value-for-money considerations.[10]
14.17
The committee believes that this is another way of saying that some
naval shipbuilding projects in Australia do attract a local build premium.
14.18
In its tender documents, Defence defines the indigenous industry
capability outcomes it requires. It explained that:
The associated cost of developing program-specific indigenous
industry capability is reflected in the overall value-for-money consideration
of achieving program objectives. [11]
14.19
Defence was 'unaware of any naval shipbuilding decision in the past 20
years that was not based on value-for-money considerations'.[12]
Whether the additional cost to construct a ship in Australia is termed an
in-country build premium or value for money, there is no reliable information
available on the extra costs involved in major naval ship construction
undertaken in Australia. Defence informed the committee:
Defence is unaware of any formal internal reviews to determine
whether undertaking naval shipbuilding projects in Australia has returned
value-for-money over time. The tender evaluation process and subsequent source
selection decision for naval shipbuilding projects and naval sustainment
contracts are based on value-for-money criteria, and this has partially
obviated the need to undertake such reviews.[13]
14.20
At the moment, Defence's method for determining cost premiums or 'value
for money' for local construction lacks transparency and has given rise to
unhelpful speculation. This lack of transparency may have implications for
industry which has no clear guidance on the policy and application of local
build premiums and for Defence's accountability. This matter of local build
premium is closely related to another area of vital importance to the
industry—the policy governing Australian industry involvement in major naval
acquisitions.
Industry involvement
14.21
Accurate, reliable and clear information on Defence's policy regarding
local Australian involvement in its major acquisition projects is fundamental
for those in the industry to plan and manage their business effectively.
14.22
According to the January 2001 Australian Industry Involvement (AII)
Manual, indigenous industry capability is 'crucial' to meeting the ADF's
capability requirements.[14]
The Manual identifies the AII Program as 'the key tool for maximising the
involvement of Australian industry development in Defence acquisition
projects...where this is cost effective'.[15]
14.23
A June 2006 Defence Industry Policy Review Discussion Paper noted
that the AII program is less transparent than what it once was. The Paper
mentions that Defence's previous method of listing specified percentage targets
for Australian industry content was ineffective in achieving particular
industry capabilities. However, it added that specifying targets was
transparent, 'and allowed industry to seek the most cost-effective solution to
the requirement'.[16]
14.24
The committee was particularly interested to obtain an understanding of the
policy on Australian involvement in major naval acquisitions.
14.25
In evidence to the committee, Defence made plain that the primary objective
of its industry policy was to ensure that there is sufficient indigenous capability
and capacity to support the operational capability of Australia's naval
vessels, once acquired. It explained that it:
uses its acquisition leverage to generate the required level of
in-country skills, technologies and capabilities to meet this objective. The
nature and level of skills, technologies and capabilities required for support
is assessed on a project by project basis.[17]
14.26
Defence advised the committee that in some projects, industry issues may
attract a higher priority in the overall process of tender evaluation.[18]
It explained that local industry involvement in its projects is approached
through a series of steps which involves Defence:
- identifying the industry capabilities it considers important for
strategic, logistical and other reasons;
- specifying industry capability outcomes for new projects, i.e.,
the outcomes it wants in terms of support services, in the Request for Tender
(RFT);[19]
and
- assessing each bid and ranking potential suppliers in terms of
the quality of their response to Australian industry and other tender
requirements.
14.27
Having defined the level of in-country activity required to meet its
strategic industrial capability needs and confident that demand is sufficient
to sustain the required level of activity; Defence takes the approach that the
remaining work should be subject to open competition on the global market.[20]
14.28
According to Defence, the principal criterion against which the
proposals are evaluated is how well tenderers' Australian Industry Capability
proposals meet the industry capability outcomes required
for the project and specified in the RFT'.[21] It informed the committee that 'a bidder's failure to satisfy
all of the Australian industry involvement outcomes set out in a RFT may
disadvantage that bidder relative to its competitors and potentially disqualify
the bidder from contention'.[22] Defence stated, however, that it 'retains the right to select
a bidder whose approach may not satisfy all Australian industry
involvement outcomes set out in the RFT if other aspects of its approach
provide offsetting benefits.[23]
Thus, while Australian industry involvement outcomes are considered important
by Defence, there may be instances where a preferred bidder is selected without
these being satisfied fully'.[24]
14.29
Defence also stated that proposals for local industry involvement are
evaluated on the basis of value for money and tenderers are required to show
how cost-effective involvement in the project by Australian industry has been
maximised.[25]
According to Defence, 'This does not always mean that goods and services
sourced from local industry must be cheaper than those available from overseas.
There may be instances where paying more for a local source of supply yields
offsetting strategic or other benefits which mean that value for money has been
achieved'. Defence explained:
The percentage or dollar value of Australian content is but one
factor. Direct benefits such as capabilities for support and savings resulting
from shorter repair times are taken into consideration in evaluation against
these criteria. Some of the less tangible benefits, such as technology transfer
and access to intellectual property, are achieved through the activities
proposed for Australian industry and form part of the evaluation of these
activities.[26]
14.30
Engineers Australia called on the Australian government to:
Clarify the strategic direction of the Australian naval
shipbuilding and repair sector so as to determine the weighting that Australian
industry development should have in the value for money calculation in the
source selection of the Amphibious Ships’ preferred tenderer and potential
prime contractor.[27]
14.31
Having questioned Defence at length about how it goes about determining
and informing industry about its requirements for Australian involvement in its
acquisition projects, the committee still does not have a clear understanding
of the department's policy on this issue and how it applies this policy. The
matter becomes even more difficult to understand when taking account of the
broader economic advantages that accrue to an in-country build.
14.32
The committee notes Defence's own statement that matters such as
technology transfer and access to IP form part of the evaluation of tenders.
Other benefits, however, 'such as potential spin-offs to industry at large and
wider benefits to the economy, such as increased employment, may be recognised
but play little or no part in the numerical evaluation. Such benefits will be
noted in advice to Government'.
14.33
Given the difficulties estimating the value of broader economic benefits,
the committee asked Defence how these wider benefits would be 'noted in advice
to Government'. It explained:
Knock-on effects such as industry skilling, regional
development, engagement of local businesses, enhanced employment opportunities
and a range of other factors will be noted in the business cases. Other
Government departments and agencies such as the Department of Industry, Tourism
and Resources, will be engaged by the AWD Program in assessing potential
benefits.
In respect of the LHD Program, the tender incorporates a
strategy which seeks as far as practicable to maximise Australian content
during the build phase, within budgetary guidance. The tender also stipulates
Australian content requirements for through-life support and mandates certain Australian
systems as costed options.
However, tenderers will also be able to submit an additional
proposal—‘Tender-Initiated Options’—which will increase the contribution of
Australian industry, but at increased cost which may exceed the guidance in the
Defence Capability Plan. The Tender-Initiated Options proposals will need to
demonstrate specifically that they offer value for money by showing the
marginal benefit of the extra expenditure that will accrue to the Commonwealth
and to Australian industry.
Tender evaluation will also consider the projected benefit of
effects on the wider economy. This element will be conducted by contracted,
independent third-party experts. The analysis will examine the tenderer’s
economic benefit assessment including the validity of assumptions, their
economic viability and the likely effects of the proposal on other major
defence projects.[28]
14.34
This explanation demonstrates clearly, why industry may be confused
about Defence's intentions and plans for the domestic industry, let alone its
commitment, to involve Australian companies.
14.35
The committee now turns to address directly the lack of information on
Defence's policy on Australian industry involvement in its major naval
acquisitions and how it applies this policy.
14.36
As noted earlier, the construction of a modern naval vessel is a major
and expensive undertaking with substantial follow-on effects that benefit the
broader economy. From Defence's perspective, an off-the-shelf purchase from
overseas may offer the capability it wants at an apparently lower cost. This
situation may well create tension between the government's desire to foster
local industry and Defence's approach based on a narrow definition of value for
money which takes account only of Defence's capability requirements and not the
economy as a whole.
14.37
Although Defence asserts that it does not consider naval procurement
decisions in terms of broader economic considerations or market influence, the
government cannot divorce itself from such considerations. It has a broader
responsibility that encompasses the whole economy. It follows that Defence's
acquisition decisions should be consistent with the government's policy on Australia's
broader industrial base.
14.38
The confusion arising from Defence's response to the committee's
questions on Australian involvement and Defence's procurement policy and
practice may well be due to a disjunction between the broader political
interest in fostering Australian industry and Defence's primary concern with
capability and value for money. There is a clear need for Defence to clarify
its position and to articulate its policy against the broader government policy
regarding Australian involvement in government funded acquisitions.
14.39
The committee is aware that Defence is currently undertaking a review of
its Defence industry policy. This will be discussed in the following chapter.
Whatever the outcome of this review, the committee sees a definite need for Defence
to articulate far more clearly its policy on involving Australian industry in
its major projects and how this policy sits within the broader government
policy on Australian involvement.
Recommendation 3
14.40
The committee recommends that Defence clearly articulate its policy on
Australian industry involvement in naval shipbuilding and repair.
Recommendation 4
14.41
The committee recommends that Defence at the earliest phase of a major
naval acquisition issue a statement on the measures it intends to take to
maximise Australian industry involvement in that project and how they fit
within Defence's broader acquisition program and the whole of government
approach to support local industry.
Recommendation 5
14.42
The committee recommends that in tender documentation, Defence provide detailed
information on the value placed on, and the weight given to, Australian
industry involvement.
Recommendation 6
14.43
The committee recommends that as a benchmarking exercise, Defence on
completion of a project, report on the measures it had undertaken to involve
Australian industry in the project and the results of those measures. The
report is to be provided to the minister for tabling in the parliament.
Conclusion
14.44
The committee notes the absence of meaningful data that would help to
inform industry about the factors that shape or influence major acquisition
decisions. The most notable areas where little information was available
included analysis on the performance of past projects especially where there
have been scheduling or budget problems, milestone assessments as a project
moves through its various stages, the policies underpinning local industry
involvement including the application of those policies and on government
subsidies for a local build. Such information would generate debate and promote
critical analysis by those interested in the industry. They would gain a better
appreciation of the factors that shape or influence major acquisition
decisions. It would also assist the industry better appreciate how the industry
is performing and enhance the accountability and transparency of naval
acquisitions. Indeed, the information made available on local build premiums
exemplified the problems associated with the way in which the government and
Defence convey information about the industry.
14.45
The following chapter examines one of the areas of concern to many of
those who participated in the inquiry—the planning process for naval Defence's acquisition
program.
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