Established in 2014 in direct response to the independent report written by Lord Currie of Marylebone that had been built around finding ways to improve scrutiny of ‘single-source’ qualifying defence contracts (QDC’s), I fear now that left to its own devices, the Single Source Regulations Office (SSRO) is at serious risk of causing permanent damage to UK sovereign defence capability.
The UK remains one of the few countries in Europe that maintains a significant level of sophisticated sovereign defence capability in the form of design, development and full manufacturing ability. Just as our military are as we know highly respected around the world for what they achieve, how they are trained and how they operate, so too is the UK defence industry also recognised and highly respected as a leader in military equipment technology and development.
The UK defence industry has an annual turnover of approximately £35 billion of which we can reliably estimate that around £8 billion of this is exported. Defence as an industry here in the UK 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 own 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 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 it seems to me crucial that the way that the SSRO has been set up should itself now 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 needs 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 ‘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 coming into play and while they had no choice but to accept the outcomes, two years on most 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.
Early next week the SSRO is expected to publish a revised baseline profit rate for single source defence contracts (those awarded without competition). Meanwhile, the jury remains out as to what the outcome of recommendation it will make to the Secretary of State for Defence ahead of the review process will be.
There are potentially big dangers ahead. Last month 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 on an industry 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. For the moment and having limited powers, although at arms-length from the MOD, it is that organisation 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 the Government appointing George Jenkins to take over the role of SSRO Chairman on January 1st the hope is that the SSRO might now settle down. It has been clear for some time that all-was not well with the SSRO structure and organisation itself. Jenkins whose predecessors over the past two years had been Clive Tucker who apparently quit the role on the basis of finding it untenable given MOD interference, and Jeremy Newman. The CEO is Marcine Waterman. Why is it that I rather doubt that many of the SSRO’s increasing number of employees really understand defence?
As said, I and others fear that there may well be serious intent by the SSRO to use the consultation document process as a means of directing a desire to become an all singing and dancing defence industry regulator – one that would have full powers of enforcement over the industry. Defence is not a utility as water, rail, gas, telecommunications and others are and where public needs a degree of pricing protection. The notion of the SSRO being given more powers makes it essential that all of us involved in defence ensure that Government understands that if it chooses to extend the powers of the Defence Reform Act and to allow the SSRO perhaps to morph into being the formal defence industry regulator, the implication is that some in the industry may well decide that continuing to do business in the UK with the MOD no longer makes sense.
In my view, allowing the SSRO to morph into something that Lord Currie clearly never intended – an all singing and dancing UK defence industry regulator – is dangerous in the extreme and that if that was allowed to occur, the UK economy and jobs would be the loser.
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 – 6th March 2017)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785