Chapter 2
Overview of Defence procurement
2.1
This chapter provides an introduction to Defence's procurement and the
procurement environment. It explains the complexity and fluidity of the
procurement environment whilst providing an overview of the scale and cost of
Defence procurement. The chapter concludes with the committee's observations on
governance and transparent feedback loops which it recognises as essential to the
effective oversight of the entire capability process and its component stages.
Capability and acquisition
2.2
In the context of defence, capability refers to the capability or
ability to 'achieve an operational effect'. Maritime, land, air and information
capabilities provide Australia with the military capability to 'meet our
strategic interests through the ability to act independently, lead military
coalitions and make tailored military contributions'.[1]
The procurement of capital equipment for defence purposes entails the process
from the 'conceptual genesis' of the project to its acceptance into service and
ongoing maintenance.[2]
2.3
Major Defence capital projects that provide the Australian Defence Force
(ADF) with new or upgraded military capabilities include armoured vehicles,
ships, submarines, aircraft, weapons, and communication systems.[3]
2.4
The procurement of capability is complex for reasons including the fact
that it is the 'combined effect of multiple inputs' as Defence highlighted:
Rather than being simply the sum of these inputs, capability
is the synergy that arises from the combination and application of these inputs
and this determines the level of capability in any particular context.[4]
2.5
Capability is defined as the effects of a system of interlocking and
interdependent Fundamental Inputs to Capability (FIC) which include personnel,
organisation, collective training, major systems, supplies, facilities and
training, support, and command and management.[5]
The committee recognises, therefore, that there are a number of key inputs to a
capability project including resources, skills including technical and
engineering skills, intellectual property, infrastructure, risk and program
management which determine the success or otherwise of a project.[6]
Further, project performance is measured by elements including cost, schedule,
risk, capability and sustainment.
Fluid and complex procurement environment
2.6
Defence explained the complexities involved in defence procurement:
Defence must acquire leading edge capabilities and
technologies to give our military and intelligence services an operational
advantage. This invariably involves significant degrees of cost, capability
and/or schedule risk not normally accepted by major companies, or found in most
of the projects that they manage.[7]
2.7
Defence emphasised to the committee that leading-edge capabilities and
comprehensive support services are 'essential to give Australia an advantage in
military operations and intelligence activities'.[8]
Defence projects are inherently complex for reasons, therefore, including the
level of new or emerging technology employed and to their scale. Indeed, as
Defence noted, complexity is a 'key factor in determining risk and the risk
mitigation measures to be applied'.[9]
Furthermore, the defence marketplace is undergoing change as Australia's major
allies are increasingly developing 'single lines' of development for complex
platforms through 'spiral' acquisition processes which require 'very early
Australian engagement if our specific needs are to be taken into account'.
Defence argued:
Highly complex and integrated weapons systems such as the
F-35 fighter aircraft cannot be purchased and then developed to suit Australian
needs within reasonable cost or risk parameters and there is no other suitable
fifth generation fighter to choose from. While providing opportunities for Defence
to be involved in the early stages of major new allied capabilities, this type
of international acquisition process limits choice, and limits our ability to
influence cost and the timing of equipment delivery.[10]
2.8
Air Marshal John Harvey, Chief of the Capability Development Group (CDG),
highlighted the level of risk involved in Defence procurement projects:
Defence projects are complex because of their scale; the
levels of advanced, often developmental, technology employed; the demanding
environments in which they must operate; and the levels of assurance required.
Procurement varies from developmental leading-edge systems with significant
capability, cost and schedule risks through to less complex off-the-shelf buys.
All these projects involve some level of risk. Risk cannot be avoided but it
can be measured, mitigated and managed.[11]
2.9
Indeed, Air Marshal Harvey continued:
In the technologically demanding and expensive defence
procurement marketplace, we have to manage risk rather than avoid it. In simple
terms, to avoid schedule risk by lengthening project delivery time frames would
deny the capability to the war-fighter in the time frame that they need it to.
To avoid cost risk by always opting for a fielded capability solution rather
than investing in the development of a new technological solution could
similarly deny the ADF a capability edge. In seeking to achieve the best
capability outcomes for the war-fighter, the best commercial outcome for
government and industry and the best value for money result for the taxpayer,
we cannot avoid risk and, even with management strategies in place, we are
unlikely to be able to retire all schedule risk from every project.[12]
2.10
These concerns were echoed by the Australian National Audit Office
(ANAO) which noted that the size and complexity of Defence major capital
acquisition projects can be at the 'far end of the spectrum experienced by both
public and private organisations within the Commonwealth'.[13]
The ANAO suggested that, against a background of significant administrative
change, there is also greater risk to be mitigated and over long periods of
time. Whilst there are means of mitigating some risk such as purchasing
equipment off-the-shelf and by focusing on the capability definition and
planning phase, there remains a need for ongoing close management over the life
of the project.
2.11
Some submitters to the inquiry also emphasised the complexity of the defence
procurement environment. Miller Costello & Company, for example, noted that
whilst Defence procurement of specialist military equipment takes place in a
market that has the same rules and behaviour as other markets, there are two
features that distinguish it:
- Complex manufacturing process required of defence products has no
peer: 'No civil industry faces the same challenges and risks in so many
technology areas'.
- The company also noted that the government acts solely and
unilaterally as both regulator and customer.[14]
This second feature and its consequences were raised by other witnesses and is
a dynamic that will be considered throughout the inquiry.
Capability development process
2.12
Capability systems in the ADF have a life cycle that begins with the
identification of the need to address a current or potential capability gap.
This need is progressively translated into a functional capability[15]
system that is operated, maintained and supported until it is ultimately
withdrawn from service.[16]
2.13
The capability acquisition process is also followed for upgrades to
major platforms which enter the Defence Capability Plan as separate projects,
particularly if they contain 'capability enhancements'.[17]
The capability life cycle [18]
2.14
Both the Kinnaird and Mortimer reviews (which are discussed in detail in
later chapters) considered Defence procurement through the capability life
cycle from the initial stages of strategic assessment where a need is
identified to address a current or potential capability gap.[19]
Both reviews considered each phase of the capability life cycle and made a
series of findings and recommendations directed at strengthening the respective
phases as well as the overall life cycle.
2.15
The committee recognises that there are key phases in relation to the
capability development life cycle that each major capital acquisition project
goes through. These phases, which are interrelated and intersect, provide the
framework of the committee's report and include:
- strategy, needs analysis and requirements phase;
- acquisition phase; and
- sustainment or through-life maintenance phase.[20]
2.16
Defence noted that the major capability procurement process links
'strategic policy to individual equipment purchases, prioritises capabilities
across Defence and ensures that capabilities are interoperable in a joint
environment'.[21]
2.17
The 2009 Defence White Paper (DWP) provides a definition of
interoperability:
Interoperability is principally concerned with the ability of
personnel and systems of different nations and agencies to work effectively
together, safely and securely. Where it makes sense to do so, and it is
cost-effective and in keeping with the policy settings in this White Paper,
capabilities and systems should be designed to be interoperable from
conception, not as an afterthought in the capability development process.[22]
2.18
Air Marshal John Harvey, Chief of Defence's CDG also explained the
concept of interoperability to the committee:
Interoperability occurs at a number of levels. In general
terms, we have to make sure that any piece of equipment we acquire is
interoperable with the system itself that it operates―for example, the
radios et cetera in vehicles, to make sure they are compatible with that. We
have to make sure that it operates with our own forces and that it also
operates with forces of any allies that we are likely to work with as well. So
interoperability occurs at a number of levels and can be achieved through
common equipment, equivalent equipment or even equipment that just works to the
same standards.[23]
2.19
Procurement of Defence major capital equipment is, therefore, complex
and can be long term, large scale and must take account of interoperability. In
order to provide leading edge capabilities, Defence must 'accept a high level
of procurement risk'.[24]
In this context, the following processes are fundamental:
- Defence White Papers—outline the strategic interests and
priorities of government as well as the broad direction of Defence policy and
tasks for the ADF.
- Force Structure Review (FSR)—underpins the White Paper and aims
to strengthen the link between strategic guidance, force development and
capability decisions. It determines the capability needs that become projects
within the Defence Capability Plan (DCP).
- The DCP provides a costed and scheduled plan for major
capabilities identified in the White Paper and any that emerge as necessary
between White Papers.[25]
- Forward Work Program—sets out how CDG will bring specific
capabilities forward for internal and government consideration.
- A series of internal quality assurance processes and committees,
working groups and other bodies as well as gate reviews to examine each
project's capability, cost, schedule and risks in detail to ensure that each
project is positioned to deliver as required.
- Consideration of major projects by the National Security
Committee of Cabinet (NSC) through the first and second pass stages and as
necessary thereafter.
- Defence review of its own performance in its annual reporting
cycle.[26]
2.20
The committee was not assured, however, that there are clear linkages
between the NSC and Defence capability and that they are auditable, have
transparent performance measures and are appropriately classified. Indeed, a
major issue for the next committee report will be to attempt to audit the links
between the NSC, White Paper, Force Structure Review, DCP and Forward Work
Program.
2.21
Furthermore, the internal reviews, audits and reporting are a major
focus of this inquiry. Evidence obtained by the committee suggests that this
feedback loop is not working properly and the committee will endeavour to
examine who is involved, how competent (qualified, experienced and independent)
they are for the role and how transparent the reporting is. As noted by Air
Commodore (Retired) E.J. Bushell, there is:
... a critical need for management feed-back loops to ensure visibility
and control of program activity and status, and to facilitate governance
oversight.[27]
2.22
Indeed, in relation to reporting, questions of independence arise when
'bad news' from technically competent people at the coal face is rolled up in
sequential summaries to be a 'green light' by the time the report reaches the Chief
of the Defence Force (CDF) or Minister. Likewise, the Defence review of its own
performance in the annual report will be examined by the committee in the
context of the linkages between the NSC guidance and capability sustained by
Defence.
Scale and cost of Defence procurement
2.23
In terms of scale, Defence noted that in 2010–11, it will spend over $10
billion acquiring and sustaining military equipment and services. In this
regard, it noted that the capital and sustainment budgets are of 'roughly
similar proportions'.[28]
However, industry witnesses estimated that the ratio for industry was one-third
capital and two-thirds sustainment over the life of a capability.[29]
Further, Defence held that:
There are over 230 approved major acquisition projects
underway, over 100 minor projects and a wide range of other procurements
associated with supporting services and infrastructure. Defence also maintains
and sustains around 100 major equipment fleets. Defence is preparing
approximately 150 not yet approved projects for consideration by government.[30]
2.24
Defence also stated that since the 2009 Defence White Paper (DWP) until
the end of February 2011, the government had approved $7.3 billion worth of major
projects, ranging across both first and second and other pass approvals.[31]
A question for the committee, however, is what would the amount have been had
projects not been deferred.
2.25
The Chief Executive Officer (CEO) of the Defence acquisition agency, the
DMO, Mr Warren King, provided an outline of DMO expenditure in relation to
major capital projects which will amount to about $11 billion for the year:
That is 42 per cent of the Defence budget and nearly 0.9 per
cent of GDP. To put that perhaps in more tangible terms, that is $45 million a
day that we have to manage, and manage well. Fifty-four per cent of our budget
is spent in Australia—so that is about $5.4 billion of the expenditure we make—and,
of that budget, we spend about $2.8 billion with Australian SMEs.[32]
2.26
Mr King further explained that DMO runs between 230 and 240 capital
projects. Of these projects, approximately 140 of them are worth more than $20
million whilst approximately 100 projects have a value of less than $20 million.
Furthermore, DMO supports 100 projects in sustainment at $5 billion a year. In
order to do this, DMO has a staff of 7500 people located across 40 mostly
regional sites around the country.[33]
At the same time, Australia's defence industry employs approximately 29 000
people and supplies in excess of $5 billion worth of material and services to
Defence each year. [34]
Committee view
2.27
The Defence capability development and acquisition process is extremely
complex and requires an understanding of the entire whole-of-life process as
well as the respective phases and component parts. The committee appreciates
that strong and well articulated linkages between strategic guidance and
capability development as well as considerations including a project's life
cycle and interoperability are fundamentally important to the process.
Furthermore, in order to allow for both the oversight of the entire process and
its components, well defined management feedback loops which work effectively are
essential. In this regard, the committee notes the observations of Air
Commodore (Retired) E.J. Bushell who articulated the importance of management
feedback loops not only in terms of enabling an understanding of the accurate
status of a project but also in relation to the effective implementation of Defence
reforms.
Feed-back loops, integrated with, but independent of,
functional management, are designed to provide current and accurate project
status visibility up through the executive chains of management and governance.
Such loops, properly resourced in skills and competencies, offer a more cost
effective and time efficient means of introducing reforms that become
self-actualising and so will not fade over time or through interference or
neglect.[35]
2.28
The next chapter will consider the Defence Reforms and their
implementation.
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