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Written evidence submitted by Jag Patel

Over the last several decades, defence equipment manufacturers have had every opportunity to build-up a portfolio of fully engineered, off-the-shelf products to satisfy the current and future needs of both, MoD and export customers – by investing in innovation, product research and development, creating intellectual property and upskilling employees – at a time when they were subsidised exclusively by taxpayers.  They have squandered this chance.

introduction

1.         It has always been the case that spending public money on the procurement of defence equipment is predicated on the maintenance of a privately-owned, sovereign defence manufacturing capability and sustainment of jobs for defence workers.  On MoD’s side, it is hard not to conclude that the existing defence procurement process was created to serve the career interests of people in the pay of the State than to procure equipment for the Armed Forces that is fit for purpose, adequately supported in-service and constitutes value for money through-life.  More recently, this government has made it a priority to spread prosperity around by increasing the proportion of MoD spend with small and medium-sized enterprises.
2.         However, recent changes in defence procurement procedures have resulted in side effects which are detrimental to the business interests of defence contractors.  These include the government’s move towards buying off-the-shelf equipment, handing-out contracts to selected UK-based defence contractors on a preferential basis and encouraging contractors to recruit staff from a narrow talent pool.
3.         This submission examines these issues and finds that the procurement and prosperity agenda is far from being realised.

buying off-the-shelf equipment

4.         The severe financial crisis at the Ministry of Defence has forced it to adopt a zero-tolerance attitude towards persistent delays and cost overruns on defence procurement programmes which has, in turn, seen it go for off-the-shelf purchases to satisfy its military equipment needs – in the shape of orders for the P-8A Poseidon maritime patrol aircraft, Apache AH-64E attack helicopters, MQ-9B Protector armed drones, Boxer armoured vehicles and now the E-7 Wedgetail, to satisfy its airborne early warning and control aircraft requirement – the latter two, after first having conducted a comprehensive market survey and then a comparative analysis of existing, in-service platforms.  All of this equipment is being sourced from manufacturers of foreign origin.
5.         This is because the government now considers buying, as its first and foremost priority, new military equipment for the Armed Forces which automatically falls in the off-the-shelf category – specifically because an off-the-shelf equipment is a fully engineered and supported technical solution which satisfies the key user requirements at no additional cost or risk to the Exchequer, that is to say, it does not require any UK-specific modifications or related development work laden with risk to be performed upon it.
6.         It is believed that a quarter of the equipment budget is currently being spent on buying off-the-shelf equipment.  This slice is set to increase dramatically by the end of this Parliament, as more and more projects which involve significant development work are side-lined in favour of off-the-shelf purchases.

Putting Financial Security and the National Interest first

7.         By choosing to buy off-the-shelf equipment, this government has put financial security and the national interest first, not defence equipment manufacturers’ commercial interests.
8.         Hitherto, it has been the practice of governments of all persuasions to hand-out uncontested development contracts on a preferential basis, to selected UK-based defence contractors – which would explain why engineered products manufactured by these contractors cost substantially more than equivalent items in the non-defence sector and why they have become seriously uncompetitive in both, the domestic market and in export markets.
9.         Some people say that buying off-the-shelf equipment from abroad means that the ability of UK-based defence contractors to develop and manufacture indigenously-designed equipment is undermined.  But the fact of the matter is that, no matter how much public money is thrown at defence contractors, the government has always been rewarded with appallingly poor performance – characterised by persistent delays and cost overruns.  The result is that they have failed to deliver equipment to the Armed Forces which is fit for purpose, adequately sustained in-service and constitutes value for money through-life, for as long as anyone can remember.
10.      Over the last several decades, defence equipment manufacturers have had every opportunity to build-up a portfolio of fully engineered, off-the-shelf products to satisfy the current and future needs of both, MoD and export customers – by investing in innovation, product research and development, creating intellectual property and upskilling employees – at a time when they were subsidised exclusively by taxpayers.
11.      They have squandered this chance.

Currency Fluctuation Risks

12.      Other people say that buying military equipment from foreign suppliers means that MoD is exposed to currency fluctuation risks which makes it necessary for it to engage in a hedging programme with the Bank of England and the Treasury, to reduce uncertainty in the near term and provide budget stability.
13.      But the fact of the matter is that, it wouldn’t be necessary for MoD to speculate with taxpayers’ money on the foreign exchange markets to forward buy foreign currency (both, US dollars and Euro), to mitigate against the risk of significant FOREX fluctuations, if UK-based defence equipment manufacturers were in a position to supply off-the-shelf equipment which satisfies the wants, needs and expectations of the Armed Forces right now.
14.      It has always been the case that paying indigenous defence equipment manufacturers to develop military equipment, and put up with the usual delays and cost overruns that goes hand-in-hand with this choice, costs substantially more than having to stump up a little bit extra, in the event the pound were to fall in value.

Government is not to be blamed

15.      The government is not to be blamed for the predicament defence contractors find themselves in.  In fact, the responsibility for this sad state of affairs lies squarely on the shoulders of successive generations of contractors’ senior management people who had every opportunity to future-proof their businesses many years ago, but didn’t – not least, because they were far too busy riding the gravy train.  The future has arrived now, and today’s top management have been caught with their pants down because they have no off-the-shelf products to sell.
16.      In other words, they are stuffed!
17.      The only way ahead for UK-based defence contractors intent on protecting their remaining market share is to self-fund the outstanding development work on their nearly market-ready products until they are fully engineered, sell them in export markets first – on price, superior technical performance, timely delivery & without bribing public officials via intermediaries – and then re-enter the domestic market with these tried-and-tested products rebranded as off-the-shelf offerings, to satisfy UK government needs.

Contractors have lost the capability to design & develop new equipment

18.      One of the reasons given by people who want the government to carry-on handing out uncontested, single-source development contracts to UK-based defence contractors – which can only be described as a Corporate Welfare Scheme – is that an indigenous engineering design, development, systems integration, prototyping and testing capability will be cultivated and maintained in-country, in perpetuity.
19.      But the fact of the matter is that the defence sector in the UK has already lost such a capability.  It went many years ago.
20.      This is because the last several decades has seen the wholesale transfer of people in the pay of the State to the private sector via the ‘revolving door’, in particular, defence equipment manufacturers’ organisations, largely due to the resounding success of the policy instituted by Defence Secretaries of all political persuasions – to encourage for-profit organisations in receipt of government defence contracts to take-on people who were previously in the pay of the State.

Mass Migration

21.      This mass migration would explain why the workforce, including senior executives within defence contractors’ organisations (right across the full spectrum of defence engineering businesses, government outsourcing contractors and foreign-owned entities, large and small) is now made-up entirely of people who were previously in the pay of the State.
22.      Whereas this targeted action has done much to alleviate the problem of high joblessness among those who had completed their terms as public servants, it has only served to deprive defence contractors of the ability to design & develop new military equipment to a user-specified technical specification requirement.
23.      This is due to the fact those who have come across from the public sector, in their middle-age, have no experience whatsoever of advancing the developmental status of the starting-point for a technical solution from its existing condition, to a point where it will satisfy the qualitative and quantitative requirements expressed in the technical specification requirement – not least, because they were never required to do so, during the first half of their career.

Design & Development skills honed within a setting driven by the Profit Motive

24.      In reality, such expertise is the sole preserve of people who were inducted into the private sector at an early age, where they honed their design & development skills within the crucible of a competitive market environment and a setting driven by the profit motive.  It also required, as a minimum, an adequate understanding of what it takes (in terms of skill types, funding, tools, processes, materials, scheduled work plan, inter-business contractual agreements etc.) to advance an immature technical solution from its existing condition.  As a consequence, these types of people are to be found exclusively in the non-defence, engineering sector of the UK economy today.
25.      The most important feature of any business that calls itself an engineering company is the existence of an in-house design, development, systems integration, prototyping and testing as a core capability.  By employing only people who were previously in the pay of the State, UK-based defence contractors have inadvertently denied themselves this capability – which has ironically, left them at risk of being usurped and displaced by real engineering companies from adjacent sectors or outside the UK, who have made it their foremost priority to invest in such a foundational capability.
26.      The complete absence of any new patent applications, IP rights or innovative products put forward by UK-based defence contractors is yet another indication of the paucity of such a capability.  It would also explain, in part, the persistent instances of delays and cost overruns on equipment development programmes – brought about by contractors not possessing suitably experienced and talented engineers, problem-solvers, innovators and doers on their payroll, right at the start of an equipment procurement contract.
27.      But the most damaging aspect of this non-existent capability is that it has resulted in UK-based defence contractors becoming seriously uncompetitive – on price, quality of products offered and most important of all, on timely delivery – both, in the domestic market and in global markets.
28.      As long as this Corporate Welfare Scheme remains in place, there will be no incentive whatsoever for UK-based defence contractors to do anything other than pay lip-service to the maintenance of a design & development capability.
29.      So, it comes as no surprise that the UK government has switched over to buying off-the-shelf military equipment after belatedly recognising this weakness in the domestic defence industry.

Attracting indigenous engineering businesses from adjacent sectors

30.      Time and again, this conservative government has made it clear that it would like see the competitiveness of the defence industry improved significantly, both in the domestic market and globally, so that the UK can pay its way in the world, post-Brexit.
31.      To this end, it has abandoned the tried-and-failed policy of talking and cajoling to try to convince the big defence contractors to become more competitive.  Instead, the government has adopted a radically different approach.  It is now seeking to accommodate additional participants in the UK defence equipment market, both at prime contractor level and right down the extended supply chain – by attracting foreign defence contractors to take up the slack at the top and indigenous engineering businesses from adjacent sectors who have not previously engaged with MoD, elsewhere in this highly lucrative market.

Latest policy statement on Defence Procurement

32.      Indeed, in its latest policy statement on defence procurement expressed in the Defence Industrial Policy[1] published in December 2017, the government says:

“Competition and innovation are mutually reinforcing.  SMEs and non-traditional suppliers, alongside universities, are the bedrock of British innovation.  We are committed to make it easier for them to do business with defence ……..”

33.      But the real reason why the government wants to widen the diversity of defence equipment suppliers is because it wants to be released from the suffocating embrace of the cabal of usual suspects, the Select Few, who have monopolised the military equipment market for as long as anyone can remember.  Indeed, this is confirmed by statistical data cited by a recent House of Commons Library Briefing Paper which reveals that a few big contractors dominate the UK defence industry.  In fact, over 42% of MoD expenditure on defence procurement for 2017-2018, amounting to over £15 billion was spent on just ten suppliers, with this market share remaining pretty much the same over the last decade.[2]  It is hard not to conclude that this stranglehold by the Select Few has been the cause of poor performance hitherto – characterised by persistent delays, cost overruns and chronically weak export performance.

Opening-up the Defence Equipment market to all and sundry

34.      The government also knows that in opening-up the defence equipment market to all and sundry, there is every chance that standout performers from the civilian arena – businesses that do real, proper engineering as their core activity (using professionally-qualified people from a wide variety of backgrounds and disciplines) – will be attracted to this highly lucrative market, bringing with them strict standards of ethical behaviour, a culture that nurtures the get-it-right-first-time philosophy and an export-orientated outlook.  These newcomers view taking part in competitions as a natural order of things and treat it as a challenge, to take market share from incumbents.  They are also used to raising private capital from the financial markets for the purpose of investing in innovation, product research and development, creating intellectual property and upskilling employees.
35.      But the greatest benefit to be derived from displacing the Select Few is that the standards of workmanship on defence contracts will be elevated to the level exhibited by the UK’s high-performing, best-in-class manufacturing businesses which are more likely to deliver value for money, and with it, lessen the burden on the Exchequer.

Shutting-out subcontractors and tolerating corrupt practices

36.      For decades now, it has been the policy of successive governments of all persuasions to hand out single-source, development contracts to selected UK-based defence contractors on a preferential basis.[3]  In fact, according to the government’s own figures, 58% of new MoD contracts by value were placed on a non-competitive basis in 2016/17, up from 36% in 2010/11 – which leads one to conclude that the trend is towards more of the same.
37.      By letting government-funded contracts in this way, MoD has shown leadership and set an example by inadvertently directing prime contractors to adopt the same method of hand picking their first-tier supply chain partners, for each dissected workshare part of their evolving technical solutions.

Old boys’ network

38.      But unlike MoD, which has been disbursing such contracts on national security grounds, prime contractors have been using the tried-and-tested old boys’ network to choose their first-tier subcontractors, usually during a gathering at the 19th Hole limited to the great-and-the-good from subsidiary companies wholly-owned by the prime contractor, or some other favoured, old school-tie chums – which has allowed corrupt activities, characterised by artificially inflated subcontract prices and the obligatory kickbacks that go with them to flourish.  It is the stupid act of disclosing the budgeted expenditure figure in the invitation to tender that has given prime contractors the opportunity to ‘divvy up’ this money in the same way as they dissected the technical solution into its workshare parts, thereby offering leeway for discretionary payments.
39.      By its very nature, this type of clandestine activity in the defence industrial supply chain is very difficult to unearth, because the extremely small number of people right at the top who benefit from it will go out of their way to keep it under wraps, citing the excuse of commercial confidentiality whilst skilfully covering their tracks.
40.      It is truly a bizarre situation, where the buyer tells the seller the price level at which he should pitch at, so that they can both profit.  A scenario which can only occur on government-funded contracts!

Epic story of Bribery and Corruption

41.      But what is especially disturbing about this epic story of bribery and corruption is that, it is instigated and perpetuated by people who were previously in the pay of the State – given that the workforce on defence contractors’ premises, large or small, is made-up entirely of former public servants who came across in overwhelming numbers, via the ‘revolving door’ to pursue a second career in the private sector.
42.      Whatever happened to the much-vaunted principles of selflessness, integrity, objectivity, accountability, openness and honesty which were supposed to define these people?
43.      What’s more, MoD’s green lighting of this practice has prompted first-tier subcontractors to also select their lower-tier suppliers in the same manner, paving the way for the entire defence industrial supply chain to be corrupted, right down to the lowest level of piece-part & component manufacturers.

Failing to spread prosperity around

44.      But the real tragedy about this whole sorry saga is that agile and innovative engineering businesses from adjacent sectors, who have not previously engaged with MoD, have been shut-out from the opportunity to act as subcontractors to these defence prime contractors, which would explain why it has failed so miserably to comply with the government’s policy of spreading prosperity around by increasing the proportion of MoD spend with small and medium-sized enterprises to 25%.  The actual figure for financial year 2017/2018 was 16.5%.
45.      Additionally, not using the market-based instrument of fair and open competition to select first-tier subcontractors has the effect of protecting these defence SMEs from being exposed to the full rigours of the free market, that is to say, shielding them ‘feeling the heat’ of competitive market forces, which has in turn, led to them becoming grotesquely inefficient, because they are simply being gifted a steady stream of uncontested subcontracts which they expect to receive in perpetuity – cultivating an entitlements culture.
46.      It is also the reason why engineered products manufactured by indigenous prime contractors cost substantially more than equivalent items in the non-defence sector – which would explain why they have become seriously uncompetitive both, in the domestic market and in export markets.
47.      It is a mystery why the government would want to tolerate this sort of criminal behaviour on taxpayer-funded contracts, given the intense focus of attention on the dubious habits of the private sector right now, and the uncertainty surrounding the continuance of free market capitalism in the UK.

Conclusions

48.      After putting up with appallingly poor performance from defence contractors for decades, this government implemented changes to its defence procurement procedures which has resulted in negative consequences for contractors – most notable, the loss of market share (and with it, profits) to foreign suppliers.
49.      The mass migration of people previously in the pay of the State to the private sector via the ‘revolving door’ has served to deny contractors a design & development capability.
50.      Far from spreading prosperity around, agile and innovative engineering businesses from adjacent sectors are being excluded from the defence supply chain.
51.      Bribery and corruption in prime contractors’ supply chains is a cause for concern, not least, because it inhibits delivery of value for money to taxpayers.
52.      The political imperative of using taxpayer funds to preserve jobs on both sides of the public-private sector divide is at odds with the government’s righteous objective of procuring equipment for the Armed Forces that is fit for purpose, adequately supported in-service and constitutes value for money through-life.

2 September 2019