The Rt Hon Margaret Hodge MP, Chair of the Committee of Public Accounts, today said:
"We welcome the progress the Ministry of Defence has made in getting to grips with its budget and military equipment costs, but real risks remain to the affordability of its 10-year Equipment Plan.
The Department admits that the costs of its £163 billion Plan could be understated by at least £5.2 billon – a figure that could grow as it develops a better understanding of the support costs involved.
If this turns out to be the case, the Department’s contingency of £4.6 billion will not be sufficient and the Department would need to draw on funds it has set aside to deliver other military capabilities.
We are not confident that the Department can deliver all the efficiency savings required from its equipment budgets. £800 million of the £4.1 billion savings required has yet to be identified.
While the Department was confident that it could deliver the planned £1 billion savings from the submarine programme, it was less certain about whether it can deliver the £1 billion savings required from the budgets for complex weapons such as guided air-to-air and anti-ship missiles.
The Department is assuming that it will receive 1% above inflation increases in funding for its Equipment Plan over the next ten years. If it receives future funding cuts, this could impact on capability unless sufficient efficiencies can be made to compensate.
Failure to improve the skills of Defence Equipment and Support, which buys and maintains military equipment, will undermine the Department’s efforts to improve control over its finances.
Ironically, DE&S is planning to spend £250 million over the next three and a half years on contractors to advise on how it can reduce its over-reliance on contractors.
There also remain risks to recruiting the required number of regular and reserve soldiers to deliver Army 2020. The Department said that it was ‘underwhelmed’ by the performance of its recruitment contractor Capita and that the IT solution proposed by Capita was unacceptable and too expensive.
The Department must up their game to meet the challenging recruitment targets and develop credible contingency plans in the event that it cannot recruit the number of regular and reserve soldiers it needs."
Margaret Hodge was speaking as the Committee published its 47th Report of this Session which – on the basis of evidence from Jon Thompson, Permanent Secretary, Ministry of Defence (MoD), Bernard Gray, Chief of Defence Materiel, MoD, Air Marshal Sir Stephen Hillier, Deputy Chief of the Defence Staff, MoD and David Williams, Director General Finance, MoD – examined the Major Projects Report 2014 and the Equipment Plan 2014 to 2024, and reforming defence acquisition.
Reliance on expensive contractors
We welcome the progress made by the Ministry of Defence (the Department) in getting to grips with its budget and military equipment costs. The affordability of the Department’s 10-year plan for buying and supporting equipment is, however, dependent on it: continuing to control cost increases in existing equipment projects; delivering ambitious project cost savings over the next 10 years in order to balance its budget; and having the right skills in place to ensure that the assumptions made in its plans are robust and deliverable. Failure to improve the skills of Defence Equipment and Support (DE&S), which buys and maintains military equipment, will undermine the Department’s efforts to improve control over its finances. The Department agrees that DE&S is over-reliant on expensive contractors and DE&S is spending a further £250 million on contractors over the next three and a half years to determine how it will address this and secure the skills needed to deliver the Equipment Plan within the assumed budget and to time.
There remain risks to the success of the Department’s Army 2020 programme designed to reduce the size of the regular Army and increase the number of trained Army reserves. The Department has not yet addressed our previous recommendations to develop credible contingency plans in the event that it cannot recruit the number of regular and reserve soldiers it requires. While the Department is reporting progress against its recruitment targets, it does acknowledge that targets beyond 2016 will be challenging and require significant improvements in performance.
£163 billion equipment budget over 10 years
Since 2012, the Department has published an annual statement on the affordability of its 10-year plan to deliver and support the equipment that the Armed Forces (the commands) require to meet the objectives set out in the National Security Strategy. This Equipment Plan is based on a detailed forecast of future project costs. From 1 April 2014 to 31 March 2024, the equipment budget is £163 billion. Each year, the Department also presents to Parliament a major projects report, providing data on the in-year cost, time and performance of the largest defence projects. In 2013–14, DE&S, which is responsible for buying and supporting defence equipment, employed some 16,000 permanent members of staff, supplemented with an estimated 3,400 contractors and had running costs of £1.3 billion. The Department launched a programme in May 2011 to improve the performance of DE&S through organisational change.
The Department is seeking to tackle funding pressures by restructuring the Army. Army 2020 is an ambitious programme of change that seeks, for the first time, to integrate fully a regular Army of 82,500 with a larger and more frequently used Army Reserve of 30,000. This represents a significant change from pre-2010 levels of some 102,000 trained regular soldiers and 19,000 trained reserve soldiers. The Department projects that this revised force size will reduce the cost of the Army by £10.6 billion between 2011–12 and 2021–22.
Conclusions and Recommendations
If the Department does not get the equipment budget it is planning for, it will have to reduce the amount of equipment it buys or reduce costs elsewhere in defence. The Department has made assumptions about its budget that are likely to be challenged during the forthcoming Comprehensive Spending and Strategic Defence and Security Reviews. The Department is assuming that it will receive 1% above inflation increases in funding for its Equipment Plan, and by 2019–20 expects equipment to take up nearly half of its budget. The Department’s working assumption is that these Reviews will be developed in concert to provide a coherent overall strategy to meet the UK’s defence requirements from 2016–17. If it receives funding cuts, the Department will need to rebalance military procurement and other costs within its overall budget. This may impact on capability if efficiencies are not sufficient to compensate for funding reductions.
Recommendation: Whatever the Department’s funding position, it is important that it consolidates the current improvements in affordability and maintains focus on a balanced budget.
There remain risks of unplanned growth in project costs. The Department’s current portfolio of major projects is relatively mature and stable, where the risk of cost growth is less. Whilst forecasting future costs is more difficult, the Department accepts that the costs of its 10-year Equipment Plan could be understated by at least £5.2 billon, a figure that could grow as it better understands its support cost estimates. If this turns out to be the case, the Department’s contingency provision of £4.6 billion will not be sufficient and the Department would need to draw on funds it has set aside to deliver other capabilities. This risk of understatement is heightened by continuing unacceptable inconsistencies in the way that DE&S project teams forecast costs, including different approaches used to forecast inflation changes, Value Added Tax (VAT) liabilities and risk.
Recommendation: The Department should continue to seek improvements in the consistency of its approach to forecasting costs, and clarify the appropriate treatment of VAT and inflation, to give it greater certainty that its Equipment Plan remains affordable.
We are not confident that the Department can deliver all the efficiency savings required from its equipment budgets. The Department told us that it was certain it could deliver £2.3 billion of the £4.1 billion savings required from the support budget and that it was working on a further £1 billion, leaving £800 million to be identified. On equipment procurement savings, the Department was confident that it could deliver the planned £1 billion savings from the submarine programme, but was less certain about delivering the £1 billion savings required from complex weapons budgets.
Recommendation: The Department should report annually in its Major Projects Report on its progress delivering the savings it requires to maintain an affordable Equipment Plan.
DE&S still lacks the skills it needs to provide the required level of performance. The Department has changed DE&S into a bespoke trading entity and given it a further two years to address the skills gaps it has had for many years that have contributed to significant increases in the cost of military equipment. The Department accepts it still does not have the skills it needs in DE&S despite years of work to reform the organisation. In 2013–14 some £480 million, some 37% of total costs was spent by DE&S filling skills gaps with contractors. DE&S’s change of status means that it now has pay freedoms and flexibilities that it believes will enable it to attract people with the skills it requires and retain them in house, reducing its reliance on contractors. However, there is no detailed plan setting out how these new freedoms will be used to secure the necessary skills while delivering the reductions in overall costs required by 2017.
Recommendation: DE&S should set out as a matter of urgency how it plans to use the pay freedoms and flexibilities it has negotiated with Treasury to improve its skills.
DE&S is planning to spend £250 million over the next three and a half years on contractors to advise on how it can reduce its over-reliance on contractors. DE&S has contracted with Bechtel and CH2M Hill at a cost of £215 million to strengthen project and programme management. It has also contracted with PWC at a cost of £43 million to determine what human resource structures would be most appropriate. DE&S expects these investments to reduce its reliance on contractor support, and transform itself into a ‘best in class’ organisation by 2017. Improved performance and reduced running costs are expected as a result, but DE&S has not yet determined how this will be achieved.
Recommendation: DE&S should set out the measures it will use to ensure successful skill transfer from consultants to permanent staff over the next three and a half years, rather than continuing to buy in expensive contractor support.
There remain risks to recruiting the required number of regular and reserve soldiers to deliver Army 2020. The Department has not taken action to address all of the recommendations made in our previous report on Army 2020. It has not yet properly addressed all of our concerns around feasibility testing for proposed projects; managing the risks around recruitment and retention of soldiers; and the approach taken to contingency planning. Risks to manning the Army remain and the Department acknowledges that meeting the target beyond 2016 requires a significant improvement in performance. The Department said that it was "underwhelmed" by the performance of its recruitment contractor Capita. In the Department’s view, the IT solution proposed by Capita was unacceptable and too expensive.
Recommendation: The Department should set out how it intends to address any shortfall in recruiting the required numbers of regular and reserve soldiers.