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Chapter 16 - Defence-an informed buyer
16.1
The report has demonstrated clearly that naval shipbuilding is an
expensive and complex undertaking requiring costly infrastructure and a highly
skilled workforce. It has also acknowledged the strategic importance of having a
navy capable of defending the country and its people, its coastal waters and
its transport and communication routes.
16.2
The changing nature of Australia's security concerns, together with the
continuing advances in technology and substantial costs of acquisitions mean
that Defence must be a savvy, competent and knowledgeable buyer. It needs strategic
analysts with the skills and experience to identify the capability Australia
needs to protect its interests, and the technical experts able to draw up and
articulate specifications and assess the technology solutions that meet these
requirements. Defence needs highly skilled project managers able to manage very
complicated tender and contracting processes and oversee delivery of complex
projects, often involving joint ventures, alliances or partnerships. It needs
leaders with the vision to look beyond individual projects to Defence's
long-term capability needs and the most efficient use of industry-wide
resources.
16.3
This chapter looks at the requirement for Defence to have the highly
skilled strategic analysts, technical specialists and competent and experienced
project managers and leaders necessary to perform as an informed buyer.
Strategic analysts
16.4
Australia's broader strategic Defence environment was beyond the scope
of this inquiry. The committee believes, however, that Defence procurement and
Australian Industry Involvement policy must derive from Australia's strategic
capability needs now and into the future. It considers, as stated in the
previous chapters, that the DCP must provide a broad analysis of Australia's
strategic requirements as the foundation for the capability plan. Defence needs
trained analysts to undertake such strategic assessment and to articulate it
through the DCP.
Technical specialists
16.5
Given its position as a monopsonist, Defence can assist industry
efficiency by ensuring that it has the technical knowledge, thinking and skills
to manage acquisitions effectively. Mr Peter Hatcher told the committee that
'it is difficult to have a good working relationship...if the customer is not
knowledgeable: that is it much easier to work with a well-informed, intelligent
customer'.[1]
16.6
Defence outlined a number of initiatives that have been taken to enhance
relevant staff skills and to improve the professional standing of DMO.[2]
DMO has been actively recruiting experienced industry personnel to increase the
skills available to conduct complex tasks such as assessing tenderers' ability
to deliver on time, on budget and at the required performance levels. DMO has
also been improving the technical skills and qualifications of existing staff.
Defence informed the committee that:
Increasing the number of chartered engineers and technical
officers is one of the key priorities of the DMO's professionalisation agenda.
Since initiating the professionalisation program in April 2004 the numbers of
engineers and technical officers who have achieved chartered status has
increased from 125 to 218. There are a further 398 enrolled and working towards
their chartered status.[3]
16.7
In addition, DMO has access to significant numbers of scientists and
engineers in DSTO to provide specialist technological advice.[4]
Depending on the complexity of a project, Defence also engages specialist
consulting companies to analyse information provided by tenderers and
independently assess industrial capacity. The companies engaged include BMT,
KBR and Appledore which are specialists in the areas of financial and
commercial management, shipbuilding and facilities and cost modelling.[5]
16.8
Not all witnesses were convinced of Defence's ability to operate as an
informed buyer. Several witnesses commented on the decrease in Defence's
technical and engineering workforce. They expressed concerns about Defence's
ability to clearly articulate requirements, ensure that proposed designs meet
operational requirements and hold contractors accountable. In the opinion of
Rear Admiral (ret'd) W.R. Rourke, the Navy needs to increase its capability
with regard to 'technological and engineering development'. He suggested that
Navy should give consideration to training officers who will be able to
participate constructively in the Navy's technological future and who would 'be
able to contribute to high quality technological management in the DMO'.[6]
Rear Admiral Scarce stated:
In my view, in the early 2000s we were lapsing to the stage
where we were not intelligent customers about naval vessels. We did not have
the skills because we were not involved in the design and detailed engineering
work of the Anzac class. We got to the stage where we did not understand enough
about building ships, designing them and integrating the weapons systems, and
we were coming close to the time where we could not warrant the safety of our
own ships because we did not have the skills to do it. That was largely there
at that particular time because we felt that it was something that industry
could do and it could deliver those services for us.[7]
16.9
Mr Peter Hatcher, Thyssen Krupp Marine Systems Australia, presented a
similar view. He commented on the shift over the last 15 years to outsourcing
Defence engineering functions and surmised:
I do not think there would be many people who would deny that
Defence is in a fairly precarious position with regard to its ability to
operate as an informed customer, from an engineering point of view. I would not
say that that capability needs to reside within Defence, but that capability
does need to reside within the country, be in an independent form and be accessible
by Defence.[8]
16.10
On the other hand, the Submarine Institute of Australia was of the view
that the ADF is held in high regard by a large sector of the international
defence community and its high standards demand high-quality products. The
Australian Industry Group Defence Council commented on the team that is being
built up in DMO, stating that:
...it has a pretty good balance of hard-headed specification type
development and it has appropriate experience... It has probably the best legal
council team that they have ever put together. They now have industry expertise
working actively inside, which they have never had before. So I would give it a
big tick at this time. But the verdict is out because, until such time as the
air warfare destroyers come through successfully, we will not know how
successful it has been—certainly, for the most complex project currently in
line.[9]
16.11
The committee notes some witnesses' concerns that Defence lacks the
necessary technical and engineering capacity internally to operate as an
informed buyer. It is pragmatic for Defence to contract expert technical advice
when this capacity is lacking. However, the committee emphasises that Defence
and DMO remain accountable to government and the taxpayer for their advice on
tender options and the ultimate delivery of acquisitions that meet specifications.
This responsibility cannot be outsourced. The committee considers it
appropriate that Defence, as part of its strategic planning, identify the
skills and expertise it requires in-house to operate as an informed buyer.
Project managers and leaders
16.12
In the main, a project is set on the path to success during its early
stages. Much of the success of naval acquisition projects depends on the foresight,
planning and skills employed by Defence and the DMO in the initial procurement
stage. Defence was aware of this role:
...before committing to an acquisition, Defence must independently
assure that industry has the capacity to deliver on schedule and within budget
the required capability.[10]
16.13
Defence informed the committee that it is responsible for the preparation
of tender documentation, the evaluation of tenders and the subsequent provision
of advice to government on preferred tenderers. Managing the tendering process
efficiently can improve defence industry profitability, in turn producing
better outcomes for Defence.[11]
16.14
Defence relies on 'the results of specific tenders to compare actual
aggregate costs relevant at the time of acquisition against a specific
requirement'. Such information is provided to Defence in a tender on a
commercial-in-confidence basis.[12]
According to Defence it uses
...commercial tendering to allow comparison of total cost to owner
against specific requirements in the economic environment prevailing at the
time. This comparison will reflect many economic factors including yard
productivity, scale of production, subsidies, other program funding and underlying
economic drivers in pricing.[13]
16.15
While Defence relies on the information provided in tenders, it needs
skilled analysts and project managers able to objectively assess this
information. This is important to avoid what Mr Warren King termed ‘the
conspiracy of optimism’. He explained:
It is not conspiratorial other than in the sense that everybody
wants to do something. So you get the situation where the military clearly want
a capability. They need a capability...industry then says—and rightly so; you can
see their enthusiasm—‘We would like to do these things in Australia,’ and who
in industry would not? So they say they can do it—let us say...for $2 billion.
The government of the day would clearly like their defence force to have that
capability, and they would like their industry to deliver it. Now you have the
beginning of what I call ‘the conspiracy of optimism’. Typically, in our
industry experience, when you put bids together, you have to hit a middle
ground: ‘How much risk; how much opportunity; what’s my price?’[14]
16.16
DMO considers that it assesses tenders against a wide range of
criterion, including weighing up factors such as operational capability and
maximising Australian industry involvement. DMO may also engage expert consultants
to analyse tenders. Clearly, managing the process of formulating specifications
and then testing tenders against these specifications, while objectively
assessing many other factors and input from external analysts requires highly
skilled project managers.
16.17
Defence also has responsibility for contracting the successful tender.
As noted in chapter 2, the growing complexity in the construction of naval
vessels, with their highly sophisticated and expensive systems, has influenced
the business arrangements for major contracts. Different contracting
arrangements and business models are used for different projects. Prime or
major contractors may come together under a range of partnering or alliance
arrangements that share project risks and project rewards.
16.18
There have been a number of significant changes to Defence tendering and
contracting arrangements in recent years. One of the most significant reforms
to Defence procurement has been the implementation of the Kinnaird recommendations.
As a result of the Defence Procurement Review, a 'Two Pass Government Approval' system for Defence projects has been
instituted to ensure that government is provided with the opportunity to make
better informed decisions regarding the procurement of Defence systems. Defence also informed the committee that it
has 'embarked on a program of continuous improvement to ensure that lessons
learned and internal and external stakeholder feedback are considered in the
development/review of procurement policy, practices and related tendering and
contractual documentation'.[15]
It outlined how, in recognition of the need to ensure that its standard
contracting procedures and templates reflect commercial 'best practice', it
commenced a 'Procurement Improvement Program' in July 2005. Defence maintained
that this initiative will benefit both Industry and Defence. It would:
- reduce unnecessary processes and documentation;
- place Defence procurement and contracting on a commercial footing
while remaining consistent with Government accountability frameworks; and
- provide increased attention to Defence and defence industry
concerns to ensure a full understanding of Defence's capability requirements
and full understanding of defence industry offers before entering into a
contract.[16]
16.19
A number of submitters commended the progress made by DMO to improve its
tendering and contracting process especially the earlier involvement of
industry. In brief, ADI was of the view that there had been a 'demonstrable
change and benefit with the establishment of DMO'.[17]
The Australian Industry Group Defence Council praised the work being done by
DMO.[18]
As well as improving the professional standing of DMO and its endeavour to
introduce world best practice in their tendering and contracting processes, DMO
has also reviewed the effects on industry of their contracting practices. It
has identified weaknesses and put in place remedies to rectify them.
16.20
Raytheon Australia was positive about the new approach. It commented
that its role as a Mission System Integrator (MSI) fitted well with the
Kinnaird process, as mission systems integration involves working with both the
customer to specify capability requirements and with industry to deliver
outcomes. Dr Stevenson said:
I guess what we are finding is that by getting with the customer
earlier and working with them we can help make sure that we have the right
documents that specify the system in going forward...basically there is a lot
more interaction between capability in DMO now than there was previously.[19]
16.21
Mr Gaul, President of CEA Technologies, commented that the Kinnaird
process provides more rigour which is healthy. He stated further:
It does cause delays, which cause us problems, but Defence is
very flexible and able to overcome that with CCP activity and things like that
in our case so that contracts can still march forward until everything lines
up. As long as that flexibility is there, I think the system will continue to
work.[20]
16.22
Mr Fisher, Raytheon Australia, commented on improvements in scrutinising
in-contract performance. He stated:
I would say that, under Dr Gumley, industry is more aware—if
your schedule is 12 months, your schedule is 12 months. But the prior practice
was that, if they brought it to nine months, they would win the job. Industry
is being held more accountable for its overruns than previously. Before that,
people used to do a CCP and just change it.[21]
Further:
From a taxpayer perspective, the process they are running today
is a good process. What it really is doing is sorting out people who used to
hide behind work in the job after they won it. That is the business approach
the DMO has now taken.[22]
16.23
Mr Peter Hatcher noted that Defence had taken measures toward developing
'more innovative contracting arrangements that break down the fixed price
contractual barrier between the customer and the supplier, in part to overcome
that lack of internal capability within Defence.' He commended this approach as
a good way of doing business.[23]
16.24
The AWD project provides an example of a cooperative contracting approach
that involves an alliance between ASC, Raytheon Australia, the DMO and the
Defence Department's Capability Development Group. In 2005, Defence tendered
for the ship build through three separate contracts: one to choose a
shipbuilder; another to choose a combat system systems engineer; and a third to
select a designer. The weapons system was purchased under a separate
arrangement. The Commonwealth selected ASC as the preferred shipbuilder;
Raytheon Australia won the contract for the combat systems engineer; while U.S.
firm Gibbs and Cox and the Spanish company Navantia are competing for the
design contract, to be announced in mid 2007.
16.25
The AWD Alliance approach reflects the complexity of the destroyer
project and the need for partnerships that bring together all the necessary
skills and expertise to meet the task of integrating high-technology weapons,
sensor and communications systems. Defence's close involvement partly reflects
its own need to keep up-to-date with this rapidly evolving capability,
particularly Raytheon's integration of the Defence-mandated Aegis combat
system. Defence also has a strong interest in developing key partnerships, both
among the alliance partners and between these companies and potential equipment
suppliers, for future warship projects.
16.26
The ability of Defence and DMO to access and draw together skills and
expertise from across companies and countries is increasingly important.
Defence and DMO require project leaders with the vision and ability to drive
complex projects, to inspire productive relationships between companies who may
operate as rivals in the commercial world and to take difficult decisions at
the outset of a project. Of all the stakeholders in an alliance or partnership
arrangement, it is Defence and DMO which require the broad vision to look for
opportunities to maximise the government's investment in a specific project. For
example, there may be opportunities to improve the efficiency of eventual
through-life support or potential spin offs to other projects and capabilities.
As discussed in chapter 15, efficient naval shipbuilding requires a
collaborative approach which looks at the most efficient use of industry-wide
resources. Defence and DMO need the leadership skills to drive this approach
and foster the necessary partnerships.
16.27
The committee is encouraged by the positive views expressed about DMO
and the progress it is making in improving tendering and contract management
processes. However, the committee considers that delivery of upcoming projects
will provide a more definite measure of the success or otherwise of such
initiatives. This underlines the importance of having in place a review process
that can gather information and assess projects as they progress through the
various phases from concept to completion.
Conclusion
16.28
The complexity of building warships in the current advanced technology,
global industry increases the demands on Defence to function as an informed
buyer. Some submitters questioned whether Defence has the appropriate level of
experience and technical expertise to carry out its naval ship acquisition
program effectively. Defence and DMO are aware of the need to have qualified
personnel in–house and are taking steps to recruit such staff and to train existing
employees. The committee considers it appropriate that Defence articulate
through a revised DCP the skills and expertise that it requires and will
maintain in-house in order to operate as an informed buyer.
16.29
DMO has undertaken steps to improve its tendering and contracting procedures
and practices. Industry's response appears to be positive. A number of
submitters commented on the improvements coming from the Kinnaird reforms and
DMO's new professional approach. Industry players especially welcomed earlier
engagement with DMO.
16.30
Even so, this report has highlighted the growing complexities in
managing major naval acquisitions, especially given the complicated network of
relationships and partnerships involved in modern naval construction projects. The
committee considers that the current acquisition schedule will provide firm
ground for assessing the progress made by DMO in improving defence procurement
practices.
16.31
Chapter 14 commented on the absence of meaningful data and information,
especially on the successes and failures of past projects. The committee
considers it imperative that such information is systematically gathered and
assessed as Defence progresses through coming major acquisitions. Such
information is important for assessing how the Kinnaird process is operating in
practice, and whether DMO's investments in staff development and innovative
contracting arrangements are yielding results. Throughout the committee's
inquiry Defence gave repeated assurances that it has the capacity to act as an
informed buyer, that it is able to conduct rigorous tender assessment and manage complex contracts. The
recommendations contained in this report provide the basis for objective
evidence, enabling these assurances to be tested, successes flagged and
weaknesses documented for assessment and improvement.
SENATOR
DAVID JOHNSTON
COMMITTEE CHAIR
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