Formed in 2015 following the Defence Reform Act 2014 which had called for a none departmental (in other words, independent of the MOD) regulator that would be responsible for issuing statutory guidance recommending a baseline profit rate and overseeing monitoring application of Single Source Procurement Framework (in layman’s terms, this is forming an then monitoring of profit levels paid out by the Ministry of Defence to contractors when such contract awards are not tendered competitively and to set a percentage allowable) the Single Source Regulations Office, which is based in expensive offices in Furnival Street in the City of London yesterday announced the appointment of 4th Chairman in under eight years.
The announcement of the new Chair was slipped out by the MOD and SSRO on Monday – a Bank Holiday in the UK – presumably in the hope that few would notice.
The original appointee as chair in 2015 was Jeremy Newman but he resigned after just short of a year in the job. The second chair was that of Clive Tucker who lasted just six months in the job and following a long and very difficult search, it was to be George Jenkins who was appointed in 2017 and who, as announced on Monday, has from yesterday been taken over as the chair of the SSRO. Has now been replaced by replaced by Hannah Dixon.
If I was to be brutal and at the same time if I am to be completely honest, fair to say that in respect of the formation and subsequent operation of a would-be regulator, that no other entity created by government in relation to defence procurement has angered an already long-suffering UK defence industrial base more than that of the Single Source Regulations Office. That anger is certainly not without good reason.
Before going further, let me make it perfectly clear that I have nothing against the choice of Hannah Dixon as the new Chairman of the SSRO. She takes on this difficult role having had widespread experience in economics and regulation across a range of industries. To that end, I do know that she was the first CEO of the Payment Systems Regulator, the economic regulator of the UK’s £80 trillion payments industry, responsible for driving competition and innovation in the interests of consumers. Ms Dixon was also a senior partner at Ofgem, where she had responsibility for the network’s division and until recently, she was also a NED of the Jersey Competition and Regulatory Authority. So, experience wise, no doubts at all as to her having the right qualities for a job that as far as I am concerned, should not exist.
By way of short background information for those interested, here are a couple of prior and subsequent events that are in my view of relevance and note:
In March 2015, the Secretary of State for Defence accepted the SSRO’s recommendation for a 10.6% baseline profit rate for the coming year (2015/2016).
In September 2015, the SSRO announced that it wanted to change the way the level of profit is calculated. The two main changes proposed were that there should be different rates for different types of work and that more comparison should be made with international defence contractors and less with non-defence British companies.
In January 2016, the SSRO announced that Michael Fallon, then Secretary of State for Defence, had failed to accept the SSRO’s recommendation that there should be different rates for different types of work. He did however, accept that the way comparisons are made should be changed.
On 9 February 2016 the SSRO’s chair Jeremy Newman resigned – apparently on the basis that he was frustrated by interference from the Ministry of Defence and which was allegedly, preventing the SSRO from doing its job.
In March 2016, the SSRO set out the following year’s baseline profit rate at 8.95%, which was lower than the previous rate of 10.6%. The announcement of the fourth
New Chairman, Clive Tucker said at the time: “It [the SSRO] was [the % level) determined by looking at the profit rates achieved by a more international and a more appropriate range of companies than had been considered under the old ‘Yellow Book’ arrangements. Previously, only companies headquartered in the UK were considered, including some with little or no relevance to defence, such as retail, pharmaceuticals and tobacco companies. This new baseline profit rate strikes the right balance between delivering a fair return for industry and ensuring value for money for the taxpayer”.
In late 2017, I had written the following in regard to the SSRO and which at the time, caused something of a stir:
Under the heading UK Defence 272 – SSRO – Danger to Sovereign Defence Capability – I suggested that the newly formed SSRO was in danger of causing serious damage to UK sovereign defence capability. Although, following his appointment, I had a subsequent private meeting with George Jenkins who assured me that he was determined to effect change, my view of the SSRO has not changed. Written in October 2014 and slightly abridged, because it remains appropriate of considerable concern to may in industry, this is what I said back then:
The UK defence industry has an annual turnover of approximately £35 billion of which we can reliably estimate that around £8 billion of this to be exports. Defence as a UK industry accounts for approximately 10% of total UK manufacturing and with over 150,000 highly skilled employees directly involved and more than double that number indirectly employed it is a hugely important industry not only for what it provides for our armed forces and in terms of exports, but also for the role that it plays in training people and in skills retention. It may be worth noting at this point that there are estimated to be around 9,000 large, medium and small defence companies operating in the UK and all, be they UK or foreign owned, play a vital role in the economy and in the prosperity agenda.
It seems ridiculous to me that in its work of examining and scrutinising single-source contract awards and what is frequently termed these days as achieving value for money for the taxpayer that the SSRO has, in its quest, not been mandated to look at or even take into account the many macro-economic benefits that the UK defence industry brings to the national economy in respect of ongoing investment in innovation and also, the role that it plays in achieving the Government’s prosperity agenda.
It is a reality just as it is also madness that the importance of the above statistics in relation to the defence industry are, in terms of its mandate, of absolutely no interest to the SSRO. Neither, unlike peer organisations in the US for example, does the SSRO have a mandate to consider sustainability of the national defence industrial base.
With a review of the SSRO by the Secretary of State for Defence due before the end of this year (2017) it seems to me crucial that the way that the SSRO has been set up should now itself come under very serious scrutiny. Everyone wants better value for money for the taxpayer and that includes industry. In my view, the SSRO really is in danger of permanently damaging and weakening the UK defence industrial base and with it remaining sovereign defence capability.
First and foremost, I take the view that both the SSRO itself and the Secretary of State for Defence need to realise that companies, particularly those that are foreign owned and employing very many jobs in Britain, do have a choice about continuing to operate here. Should they choose to believe that the odds are now stacked against them in terms of fairness why on earth would they continue to invest? The point is that we need all of them and we should certainly not want any of them to pull out of the UK.
The SSRO is in my view far too overly concentrated on ‘value for money’ and of what they regard as being a fair rate of return. Not surprisingly, in determining the future baseline profit recommendations there have been serious concerns expressed by industry in respect of what the SSRO term as allowable costs and of what they regard as being attributable and reasonable.
Neither does the SSRO appear to take into account that through a period of sharp defence cuts and delays in ordering of equipment that raises costs followed maybe later by cuts in the actual numbers ordered together with other factors such as taking a greater degree of programme risk as industry now does, also has a huge bearing on how industry needs to calculate its cost.
What industry requires from the SSRO is knowledge that when calculating the baseline profit that all the above factors are taken into account together with the need of the SSRO to begin recognising the importance of the UK defence industry to the overall UK economy.
Having spent several weeks looking the subject for this particular ‘Commentary’ today it is sad that I find the need to be negative about the role of the SSRO. I do not believe that what has emerged is what Lord Currie had planned and I am bound to be extremely concerned about what it may ask for in terms of additional powers ahead of the regulatory review process later this year.
Industry wants and needs a far better approach and collaboration with the MOD and the SSRO to sort some of the many issues out before further damage is done. It wants and needs the SSRO to be more business-like in its approach with both itself and the MOD as opposed to overly concentrating purely on self-directed and assumed industry costs that exclude far too many of those that it that they are not prepared to take into due consideration.
When it comes to agreeing the arbitrary baseline profit percentage, a limit figure that the SSRO places on MOD single source contracts, there is also need to take ‘third party’ contracts into account. It is also true to say that, apart from contracts that the MOD restricts SSRO access to such as those that come under the category of Foreign Military Sales (FMS) plus others withheld maybe on security grounds, the SSRO has struggled in terms of numbers of individual contracts that it has been involved in investigating.
True to say also that the UK defence industrial base has worked very hard to make itself more efficient over the past few years and while there remains further work to do few inside industry would argue that greater transparency in defence procurement in order to ensure that the taxpayer gets best value for money is absolutely right.
As far as I can see, the SSRO was imposed on industry with very little serious prior-discussion ahead of the Defence Reform Act 2014 and while they have had no choice but to accept the outcomes, two years on most [in industry] appear to agree that the SSRO is damaging the industry particularly through its failure to take into account medium and long term investment that industry continually needs to put in to ensure that it stays ahead of foreign competition.
This, along with other factors already mentioned including the need in its reconciliation of profit allowance to accept the value of what the defence industry brings to the UK economy are major reforms that need to be better agreed in the upcoming review.
Worse to an extent is that ignoring all else, the SSRO is also likely to seek even greater powers than it already has ahead of the review process and that if allowed, would almost certainly lead in my view to a further big contraction of UK sovereign defence capability.
There are potentially big dangers ahead. In November 2017 the SSRO executive issued a consultation document that reflects, as previously mentioned, the requirement that Secretary of State for Defence has under the Defence Reform Act 2014 to review the work of the SSRO by December 2017.
Concern over the SSRO consultation paper is justified on the basis of fears that the organisation appears to be using the excuse of ‘inviting ideas’ in order to use the consultation document in order to put forward ideas of its own in relation to calling for much greater powers and turning itself into an all-embracing defence regulator. Expressed fears are hardly unfounded and it is, I believe, the potential of the SSRO being given extensive additional powers and perhaps being transformed into a formal defence industry regulator in the like of Ofcom and other industry regulators that we should worry about most.
The SSRO can also be expected to use the consultation period to demand far greater transparency meaning that I suspect it will seek powers to not only examine all single-source contracts but also, individual commercial contracts between contractors and their suppliers. Such in my view would be completely unacceptable and much of this is commercially sensitive information and must remain private to the specific organisations involved.
Currently, the statutory baseline profit limit placed by the SSRO on single-source defence contracts is 8.95%. Tis is far too onerous. Yes, there are other available options and variables such as that if defence contractors are prepared to take on full cost risk or maybe allow themselves to be tied into agreed performance targets, the profit percentage allowance could in such circumstances rise to a maximum 13.19%. Given the requirement to invest and the value that the defence industry brings to the economy, the current level of statutory baseline profit placed on industry bares no merit.
It is hardly surprising that almost ‘across the board’ industry has expressed such deep reservations and concern not only in regard of the statutory baseline level set and seeming lack of understanding of the value that the defence industry brings to Britain, but increasing about the SSRO itself and how it goes about its business in a heavy handed doctrinal manner.
Seen by some in industry as being yet another unwarranted and unnecessary attack that over the past few years has already suffered from serious cuts in defence equipment purchases and programme closures particularly as a result of SDSR 2010 together with orders being cut, reduced in size and scale or maybe just being pushed back to save MOD cash-flow, it is the ignorance of the SSRO in respect of understanding and appreciating the difficulties that industry has of working in such an arena and the failure to comprehend the value of the industry to the economy plus ongoing efforts and value of work done by industry to reduce costs and pass savings benefits on to the taxpayer that has annoyed industry most.
Industry is not alone in having serious concerns and tensions with the SSRO as it appears that the MOD has serious misgivings and concerns as well. There is an understandable fear by all sides that the SSRO has a lack of understanding in respect of commercial contract sensitivity and that while the SSRO does not currently have extensive powers outside of recommendation of baseline profit percentage and the requesting of documents relating to single source contract agreements, the fear is that if given more extensive powers the SSRO will seek to examine in detail all documents relating to single source procurement programmes including those with third parties. From a commercial aspect this would be as dangerous and it would surely be unacceptable.
The MOD has certainly not seen fit to allow the SSRO to have sight of all contracts and neither has it been prepared to allow the SSRO to have sight of material contract amendments. That is because of confidentiality agreements between customer and supplier. For the moment and having limited powers, although at arms-length, it is the MOD that controls most of what the SSRO is allowed to see and engage in. This partly explains why actual numbers of single source contracts that the SSRO has so far examined are to be considered very few in comparison to the number of single-source contracts awarded.
With innovation and the prosperity agenda now high on the list of government priorities and with the MOD and Department for International Trade keen to support UK defence exports it seems clear to me that if profit constrictions on industry sales to the MOD are considered too onerous then by equal measure this will confound the ability to achieve greater level of defence exports. If the SSRO fails to align its process with longer term defence market consideration and application preferring to concentrate solely on short-term gain in isolation then I believe that the industry as we know it will decline. The hope will be that nothing will be done by the Secretary of State for Defence within the formal SSRO review process that is in isolation with industries views and reasoning.
CHW (London – January 5th 2022)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785