ministry of defence design and procurement of warships

NATIONAL AUDIT OFFICE

Report by the Comptroller and Auditor General

Ministry of Defence: Design and Procurement of Warships

Ordered by the House of Commons to be printed 5 June 1985

LONDON HER MAJESTY’S STATIONERY OFFICE E3.30 net

423

This report is presented to the House of Commons in accordance with Section 9 of the National Audit Act, 1983.

Gordon Downey Comljtroller and Auditor General National Audit Office

4 June 1985

Contents


Summary and conclusions

Report Part 1: Background Part 2: Division of Responsibilities for Warshipbuilding Part 3: Effectiveness of MOD’s Design and Development

Arrangements Part 4: Performance of Warshipbuilders Part 5: Negotiation of Warship Contracts

Glossary of abbreviations 18

Appendix Mr Levene’s recommendations on warship procurement

Pages l-5

6 7-8

9-12 13-15 16-17

19

Background


Summary and conclusions

1. This Report records the results of an examination by the National Audit Office (NAO) of the Ministry of Defence (MOD)‘s arrangements for design and procurement of warships. It covers the progress made in increasing warshipbuilders’ involvement in and responsibility for design; the difficulties encountered in design and development of new ships; and MOD’s influence on the performance and productivity of the warshipbuilders and the effect of the latter on the achievement of value for money. These matters have all been the subject of earlier Reports by the Public Accounts Committee (PAC). I intend to provide PAC with further details to supplement this Report, on a confidential basis.

2. The NAO examination showed that MOD are progressively increasing warshipsbuilders’ responsibilities; as a consequence the direct effort employed by the Ministry is reducing, partly due to staff cuts. This will reduce the level of oversight but MOD informed me that it will be relying on the terms and conditions laid down in its contracts to protect its interests. Although in general warshipbuilders’ performance~on quality and delivery appears to have improved in recent years, there are problem areas which require further attention by MOD, in particular the coordination of development of ships and their weapons. A cautious approach to further transfer of responsibilities seems necessary and there is a need to assess, as far as is practicable, the cost-effectiveness of such transfers and of proposals to contract out work arising from staff cuts. On pricing the evidence on warshipbuilders’ productivity and the outturn on MOD contracts suggest that MOD may not always have received value for money in terms of the cost of warships, but that improvements are likely as a result of action taken in recent years. As the warshipbuilders’ major customer, MOD should be able to influence improvements in performance and productivity by continuing to place emphasis on competition, by maintaining the efforts made recently to negotiate tougher non-competitive contracts with prices linked to improvements in productivity, and by maintaining a dialogue with the warshipbuilders to facilitate shipbuilders’ forward planning and to ensure that ah potential means of improving value for money are properly appraised and fully taken into account in determining policy and in individual decisions.

3. The construction of a modern warship involves the fitting of increasingly complex and sophisticated weapons and equipment, based on the latest technology. The development and production of weapons, particularly for major warships, is usually subject to separate contracts placed by MOD with the specialist manufacturers. Contracts with shipbuilders for major warships normally provide for the fabrication of the huh, the procurement of most ship equipments and the fitting of weapons and equipment. In June 1984,21 major

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Conclusions

warships were on order for the Royal Navy (RN). Annual expenditure on procurement of ships and submarines, excluding separate weapons and equipment contracts, exceeds f500 million; the total value of contracts placed with the UK shipbuilding industry, including the capital cost of weapons and equipment, is about f2,700 million. Of this some f2,OOO million is spent by the shipbuilder either directly (about 30 per cent), or indirectly through sub-contracts for equipment and materials. Intra-mural costs, including staff supporting the running fleet, are about f30 million per annum; the number of staff involved has fallen by a quarter since 1971 and further reductions are planned.

4. NAO examination did not cover contracts for weapons but the Report deals with the effects of weapon development problems on warshipbuilding. Although the NAO did not visit British Shipbuilders (BS), their comments obtained through the Department of Trade and Industry (DTI) on extracts from the draft report have been incorporated in the relevant paragraphs. The NAO has also recently seen the report on warship procurement made in July 1984 by Mr Peter Levene in his capacity as Personal Adviser to the Secretary of State for Defence (Secretary of State). His recommendations on areas covered by his report and my own are broadly consistent with the NAO findings and are referred to in appropriate paragraphs of Parts 2 to 5 and the Appendix.

Division of responsibilities 5. MOD are seeking to increase shipbuilders’ responsibility and liability for design and other warshipbuilding tasks. I note that maximum devolution to industry is seen by MOD as bringing advantages such as easier incorporation of “buildability” into design and greater opportunity to consider export potential and that BS believe improved efficiency would result. Disadvantages include some loss of flexibility arising from dispersal of design resources to the three lead shipyards and the progressive increase in delegation of responsibilities to the warshipbuilders is accompanied by reduced MOD control and oversight, resulting partly from staff cuts. MOD have not to date been able to assess the overall cost-effectiveness of the changes taking place, although they intend to undertake studies in later years. There is thus some risk that the changes will not result in better value for money.

6. The following specific comments relevant to the division of responsibilities take account of the examination of current projects referred to in Part 3 of the Report:

(a) MOD intend to maintain a core of intra-mural expertise to enable them to act as an informed customer and to explore the prospects of appointing a prime contractor with responsibility for the whole ship, including weapons and equipment. I consider it desirable that MOD should follow up the Penny Report’s proposal that they should pursue cost-effectiveness studies and, as far as practicable, quantify the advantages and disadvantages of the overall division of responsibilities and specific proposals for contracting out. As policy develops the balance of advantage in cost-effectiveness should be carefully monitored (paragraphs 2.5-2.9).

(b) Although MOD are generally satisfied with warshipbuilders’ quality assurance, standards at contractors are not always satisfactory: MOD are considering the value of obtaining extended guarantees with shipbuilders taking more responsibility for achieving acceptable standards (paragraph 3.17).

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(c) The degree of MOD involvement in design may, as in the case of the Seabed Operations Vessel (SOV), affect their ability to pursue claims in respect of defects and therefore lead to extra costs. The SOV case illustrates the importance of responsibilities for design and liabilities for defects being clearly identifiable and dispersal of responsibilities should be avoided (paragraph 3.18).

(d) There are problems in weapons development and their coordination with ship development; these are obstacles to the appointment of whole ship prime contractors. They are being reviewed by MOD’s new warship planning unit and MOD have told me there are encouraging signs that the problems are being solved for future projects (paragraphs 3.19-3.21).

Effectiveness of MOD’s design and development arrangements 7. MOD’s objective is to procure warships to be delivered on time, of good quality, at a reasonable price and capable of fulfilling the operational requirements for which they were designed. Action is being taken by MOD or is under consideration to remedy deficiencies in some earlier ships to enable them to fulfil their full operational role as currently defined and MOD are seeking to remedy in new and, where practicable, existing ships some deficiencies identified following the Falklands experience. On individual warship projects, in general, MOD have learned the lessons of the problems which arose on earlier ships and taken the necessary action. The current position on delivery and quality of ships received from the warshipbuilders is generally satisfactory and appears to have improved since PAC considered problems in development of new warships in the mid 1970s. However NAO examination showed that some difficulties are still being encountered in design and development.

8. The following specific comments arise from NAO examination of current projects:

(a) There is some risk of delay with ships currently under development, in particular in bringing some new ships to full operational effectiveness because of the problems in weapons and equipment development and their coordination with the ship construction programme (paragraphs 6(d) and 3.19-3.21). Delays and cost increases have occurred mainly in the planning stages, eg because of changes in requirements, before contracts for warshipbuilding were let but the SOV, a vessel with unique capabilities embodying advanced technical facilities, has suffered from severe cost escalation and delay (paragraphs 3.15-3.18).

(b) There is a need, which MOD recognise and aim to meet, to remedy current weaknesses in ship acceptance documentation for non-weapon equipments to ensure shipbuilders meet RN and contractual requirements. MOD are reviewing these acceptance procedures (paragraph 3.22).

(c) A contributory factor to delays in some cases has been shortages in warship design resources and MOD have informed me that the quality of those resources is also a cause for concern. BS disagree and do not believe it would be sensible for them to employ sufficient staff to cope with peaks of demand. Although MOD have a role in consideration of overall design resources they are not in a position to control those deployed by shipbuilders. To meet this they are placing more emphasis on long term planning of resources through the warship planning unit, but their influence remains limited at present (paragraphs 3.23-3.25).

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Performance of warshipbuilders 9. The productivity of the warshipbuilders affects the cost of warships to MOD and is therefore vital to the achievement of value for money; the NAO examination indicated that productivity and cost have been less satisfactory than quality and delivery, although MOD believe the evidence is not conclusive. It is difficult to make valid comparisons with productivity overseas but evidence from various informed sources, including BS themselves, has in the past suggested that productivity of some of our main overseas competitors was significantly better than that of United Kingdom yards. No export orders for major warships have been gained in the last ten years, although some smaller ships have been sold; in January 1980 BS stated that a productivity improvement of 25 per cent was needed to gain potential export orders, although other factors do of course affect the placing of orders. BS planned to achieve the desired 25 per cent improvement by 1985 but the shipyards are significantly below their targets, although improvements have been achieved on some programmes and major improvements are expected from a 1983-84 agreement ending restrictive practices. At Vickers Shipbuilding Engineering Ltd (VSEL) BS claimed, although MOD did not accept, that productivity declined during the 1970s and new bonus schemes and capital investment in the last five years had only partly recovered this by March 1984; further significant new facilities are under construction which should improve productivity in the future. BS have a continuing programme of improvements in construction techniques etc in hand (paragraphs 4.1-4.3).

10. NAO examination indicated that:

(a) Since the 1970s and until recent years, MOD have not exercised a strong influence to improve the productivity and performance of contractors. This was partly because they have suffered in negotiation from lack of information on productivity changes by contractors. Following assurances given to the PAC in 1977 and 1979 MOD have in the last few years increasingly been able to base negotiated contracts on anticipated improvements in productivity (paragraphs 4.4-4.8).

(b) MOD should use their position as the main customer, whose orders constitute a substantial proportion of turnover at the main warshipyards, to maintain a dialogue with the shipbuilders on matters such as productivity and performance and the scope for improving value for money by other means (paragraph 4.9).

(c) BS consider that the fundamental questions of competition, capacity and batch ordering are of considerably greater importance than the contractual process in determining whether the Government is getting value for money in its warship procurement and that the latter might also be achieved in other ways, for example by introducing exportable designs (paragraph 4.9).

(d) The recent decision on the orders to be placed for 2 Type 22 frigates and the second Type 23 frigate appears to indicate a departure from the policy pursued by MOD in recent years to obtain better value for money by the maximum use of competition and will result in extra costs to public funds, part of which will fall on the Defence Budget, as a result of the decision to support Cammell Laird (CL): MOD however also seek to maintain capacity and believe there will be offsetting savings (paragraphs 4.10-4.12).

(e) Competition for the Type 22 orders did not extend to profit rate. This followed a direction from BS that the yards should compete on cost and efficiency but not on the return to their public sector shareholders and that

they should therefore use a common rate of profit. This rate was greater than the Government Profit Formula rate for non-competitive contracts (paragraph 4.13).

(f) MOD need to balance the extra cost of maintaining the current over capacity in United Kingdom warship yards against the expected benefits resulting from competition: DTI and BS have questioned whether the present degree of over capacity is required and whether better value for money in warshipbuilding can be obtained in other ways. Decisions on designs and orders rest with MOD but it is important that the potential improvements identified by the shipbuilders should be properly appraised and fully taken into account by MOD in determining policy and in individual decisions (paragraph 4.14).

Negotiation of warship contracts 11. Most of the work of the five main warship yards is to build ships for MOD under both competitive and non-competitive contracts; there is also a small amount of export work. Since 1980-81 BS have reported warshipbuilding profits of f185 million. During the same period the remainder of BS has made losses of f525 million. The warshipbuilding profits since 1980-81 have represented more than 11 per cent on cost. Target rates of profit of just over nine per cent have been payable under the Government profit formula on non- competitive contracts, which accounted for more than 70 per cent of work for MOD during the period. Despite the weight of opinion and evidence that there is room for considerable improvement in productivity, warshipbuilders have consistently underrun estimated “build hours” and in some MOD non-competitive contracts have earned the maximim profits allowed on such contracts. Although other factors affect outturn, and the average differences between labour costs estimates and outturn have been less than the man hours variations, these results cast doubt on the accuracy of original estimates (paragraphs 5.1-5.5).

12. Thus in terms of the prices paid for warships, the evidence on warshipbuilders’ productivity, the outturn on MOD contracts and the profits made by the warshipbuilders in the past suggest that MOD have not always received good value for money. In the past four to five years they have taken steps to improve the position, by the enhanced use of competitive tendering, more stringent estimating, leading to contract conditions which give real incentives to the supplier, and tougher negotiations on build hours based on improved levels of productivity. It is however still too early to assess the results and MOD need to maintain their efforts, particularly in view of the trend to place more responsibility on shipbuilders (paragraph 5.8-5.10).

13. I note further that although there are generally expected to be fewer non- competitive contracts in future, there will be substantial non-competitive orders placed with VSEL for nuclear submarines; that productivity at VSEL has been a cause for concern and negotiations with the company have been difficult (paragraphs 5.6 and 5.8).


Report

Part 1: Background

1.1 This Report records the results of an NAO examination of MOD’s arrangements for the design and procurement of warships. In June, 1984 21 major warships (each costing in excess of f30 million) were on order for the Royal Navy. The annual expenditure on the production of ships, including submarines, and including First of Class (FOC) design expenditure, through the MOD Sea Systems Controllerate (SSC) is in excess of f500 million. The UK warshipbuilding industry currently has MOD procurement contracts valued in total at about f2,700 million, including the capital cost of weapons and equipment. Of this some f2.000 million is spent by the shipbuilder, either directly or indirectly through sub-contracts. Typically some 30 per cent of the cost of a warship is incurred directly by the shipbuilder. Costs quoted in this Report areat 1983-84 prices unless otherwise stated.

Service staff cuts but have also been related to a transfer of some responsibilities to shipbuilders.

1.4 MOD’s objective is to procure warships to bedelivered on time, of good quality, at a reasonable price and capable of fulfilling the operational requirements for which they were designed. The NAO examination concentrated on the procedures adopted by MOD to achieve this objective and the progress made in instituting improvements recommended in past Reports of the Public Accounts Committee (PAC). Parts 2 and 3 of this Report review the arrangements between the MOD and the shipbuilders for sharing design effort and the effectiveness of the MOD’s arrangements for design and development of warships. Parts 4 and 5 assess the effect of the performance and productivity of the warshipbuilders on the achievement of value of money, and MOD’s influence on them.

1.2 The construction of a modern warship involves the fitting of increasingly complex and sophisticated weapons and equipment, based on the latest technology. Contracts with shipbuilders for major warships normally provide for the fabrication of the hull, the procurement of most ship equipments and the fitting of weapons and equipment. The development and production of weapons, particularly for major warships, is usually subject to separate contracts placed by MOD with the specialist manufacturers. These contracts wereexcluded from thestudyon which this Report is based, although the effect on warshipbuilding of problems in development of weapons and equipment is discussed below (paragraphs 3.19-3.21).

1.5 The main warshipbuilders have in recent years all been a part of BS, although the Government’s intention is to complete the privatisation of the warship yards by 31 March 1986. The NAO have not visited them during this study but BS have provided comments through DTI on relevant paragraphs of the draft report and these are now incorporated in Parts 2 to 5.

1.3 Intra-mural costs for warship work, including staff supporting the running fleet, are about f30 million per annum. Total SSC manpower levels have reduced by some 26percent since 1971(8,31Oto 6,090); a further reduction to 5,770 at 1 April 1985 was planned. Within the SSC, Deputy Controller Warships (DCW), who is responsible, when the Naval Staff Target (NST) has been approved, for design, development, production, introduction into service and support of all warships (except for certain aspects of stra- tegic submarines) to meet approved MOD requirements, has a supporting staff of about 2,150, with a reduction to 2,000 planned for 1 April 1985. One-third of DCW’s staff are involved in project management. There is also support from other SSC staff responsible for conceptual design studies and for contractual arrangements. Reductions in SSC com- plements have been part of the general MOD and Civil

1.6 While the NAO study was in progress, Mr Peter Levene made a report on warship procurement in July 1984 in his capacity as a Personal Adviser to the Secretary of State. I obtained a copy of Mr Levene’s report only in April 1985 after my report had been drafted and Mr Levene had been appointed Chief of Defence Procurement. His recommendations and Controller of the Navy (C of N)‘s comments are listed in the Appendix and I refer to them in appropriate paragraphs of this report. In areas covered in both reports, in general my findings are consistent with Mr Levene’s recommendations. MOD have welcomed the general thrust of Mr Levene’s report, although disagreeing with some of his detailed comments, and have informed me that action on the report would be linked with action on other reports to the Secretary of State aimed at making MOD’s approach to procurement generally more commercial. The Appendix refers to another report by Mr Levene containing more general recommendations concerning the procurement of all equipment for the armed forces, including warships. I shall refer to these recommendations in my forthcoming report on the Production Costs of Defence Equipment.

Part 2: Division of Responsibilities for Warshipbuilding

2.1 The MOD no longer builds its own warships; this work is undertaken solely by the UK Shipbuilding Industry. MOD has however continued to play a significant although progressively less involved role thoughout the warship design process.

2.2 Following unsatisfactory arrangements for the design and FOC production of two major warship classes in the late 196Os, one designed in MOD and one in industry, MOD informed PAC (5th Report 1975-76) that they were involving the shipbuilder in plans for a new class of warship well before the first production contract was placed and were no longer letting such contracts on a competitive basis. Since then there has been greater cooperation between MOD and the warshipbuilders and the latter have gradually been given more responsibility at a much earlier stage of the design process but to varying degrees in different circumstances and cases. In December 1983 the Penny Report prepared by a joint working party including representatives of MOD, shipbuilders and relevant university departments noted that for two new classes of warship, less than 15 per cent of total design work effort measured in man-years had been carried out in-house. Penny supported the existing split of responsibilities for design work and concluded that responsbility for concept design work and management of the feasibility stage of design work should remain in-house, but using industrial resources to the maximum, and that detailed design should continue to be carried out by industry. The MOD contribution changes from predominantly conceptual and technical work in the early design stages to audit, design review and project management at the working drawing stage.

2.3 In most other major warshipbuilding countries Gov- ernments have in-house capability for design work although two have partly independent but closely supervised design agencies. In BS’s view the proportion of design work carried out in-house by Governments is lower in some of these countries. MOD disagree although they considered the case for “hiving off” warship work to a design agency in 1982. This was rejected as unlikely to be cost-effective, although no detailed proposals were costed. MOD were particularly con- cerned that design resources should not be remote from the FOC production base. They have informed me that with privatisation on the horizon, “hiving off” would not be viable in the next five to ten years, but BS saw no strong reason why “hiving off” should be further delayed by privatisation, which is due to be completed by 31 March 1986.

2.4 Mr Levene in his report (para 1.6 and the appendix) reviewed the balance of effort in warship procurement between MOD and industry. His general recommendations on Defence procurement applied also to warship procurement and were aimed at creating a leaner, more free standing and effective SSC with wide authority and responsibilities, operating in a commercial atmosphere across the whole naval equipment field. His specific recommendations were aimed at putting more responsibility and liability with industry and reducing in-house effort to match the transfer of functions. I endorse C of N’s comment on the latter that MOD must be careful not to go so fast that it gave up essential tasks and safeguards before industry was ready to take them on and at a price MOD could afford.

2.5 One possible future development is the appointment for major warships of a prime contractor with contractual responsibility for the whole ship, including weapons and equipment, an extension of the existing “design and build” procurement arrangements for small vessels. An internal MOD Report in August 1982 concluded, after taking evidence from outside authorities, that the “design and build” contract process for auxiliaries and minor vessels had been carried virtually to the limit. However the more widely- based Penny Report in December 1983 recommended that the process should be extended to the procurement of an appropriate minor warship, including its weapons systems, so as to assess the practicability and scope for the use of this method. MOD believe that the shipbuilder is not necessarily best fitted for the prime contractor role, because of the complexity of modern weapons and other problems referred to in Part 3, and Mr Levene endorsed the development of the role of the major weapons companies as prime contractors. However, BS believe that the shipbuilder is the only person that can take the lead in a ‘design and build’ procurement arrangement. They point out that the ship is the platform upon which a variety of weapon systems is carried. In their view the production of the whole is liable to be slow and inefficient, and the resultant design unsatisfactory, unless the whole ship is designed with a view to efficient production and efficient and flexible weapons fit.

2.6 The Ministry sees design and build necessarily as an evolutionary development. Harland and Wolff are prime cntractor for conversion of a merchant ship into an Aviation Training Ship (ATS); the Aviation Support Ship may be another example. MOD plan to extend their experience with the more complex Auxiliary Oiler Replenishment (AOR) vessel where tenders have been invited from both shipbuilders and weapons manufacturers for the whole ship; the feasibility study design work has been contracted out to industry, although the FOC builder will not necessarily use the resultant design. None of these vessels is strictly a warship but MOD are also considering prime contractorship as one of the options for the procurement of a minor warship, the Mark III Offshore Patrol Vessel. Prime contractorship for the build of the AOR will present considerable problems in view of the sizeable weapon fit planned and the Ministry doubt whether industry could handle a more complex warship under such arrangements at present.

2.7 MOD informed me that greater involvement with industry and the devolution of designtasks to industry could not have began much earlier than the 1970s because of lack of centralised industrial resources and facilities; the evolutionary process had not been without its set-backs, largely through fluctuations in industrial capacity and order books, and could only proceed in line with industry’s competence to undertake the work. However, MOD believe the general goal to concentrate limited ship design resources in industry into the few lead yards able to support this effort and produce FOC vessels is being attained; a core of intra-mural expertise will be maintained to enable MOD to act as an informed customer. Because of pressure on staff resources MOD are currently considering contracting out some design and related tasks normally carried out in-house.

2.8 The Penny Team were asked specifically to assess the overall cost-effectiveness of carrying out design or related work in-house compared with in industry but were unable to do so because of lack of time. Penny did however recom- mend that MOD should pursue cost-effectiveness studies. MOD have since informed me that it was not possible to carry out a valid comparison and that in any case they were firmly committed to the policy of devolving as much design work as was practicable and sensible to industry. I note that disadvantages would include the loss of flexibility arising from fragmentation of the design task and the resources required among three lead shipyards, compared with con- centration in MOD, and some loss of MOD control arising from less in-house expertise. BS believe that this would be more than compensated for by the real benefits in building time and in efficiency which design by designers familiar with modern ship production processes could achieve. MOD also consider that these factors, and the greater opportunity to take the export market into account during the design process, would produce unquantifiable benefits.

2.9 MOD’s evolutionary approach to the transfer of responsibilities to shipbuilders seems necessary in the light of the problems identified in Part 3 of this Report. The NAO suggested that there was a need for MOD to follow-up the Penny Report’s proposal for cost-effectiveness studies and assess the advantages and disadvantages, quantified as far as practicable, of the current and proposed division of responsibilities and of specific proposals for contracting- out. They have informed me that studies will be made to see if the process of devolution has been cost-effective when substantial evidence is available from the design and production of the Type 23 frigate and the latest methods of procurement with the ATS and AOR. They have stated, however, that while it may be possible to make a broad assessment of relativecosts, relativeeffectiveness would be a much more subjective judgement which will take several years to assess, while it is not a practicable proposition to turn the clock back on devolution.

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Part 3: Effectiveness of MOD’s Design and Development Arrangements

3.1 In the absence of an assessment of cost-effectiveness by MOD, the NAO examined the available evidence on the effectiveness of MOD’s current arrangements for design and development of warships. This included a review of the recent history of the Type 42 destroyer, which was the subject of earlier consideration by PAC, to establish the long term effects of the earlier problems and whether lessons had been learned, and of three new ships under development.

Ge*.Xal 3.2 Cmnd 8758 dated December 1982 stated that following an independent post-Falklands review it was clear that RN ships were strong and reliable platforms able to operate con- tinuouslyat seaevenin themost difficult weatherconditions and no fundamental design defects had been identified. However some important lessons had been learned and measures were being taken to improve the survivability of existing ships and to incorporate lessons in future designs. The review of the Defence Scientific Advisory Council identified two general deficiencies, the vulnerability of ships to fire and smoke and the provision made for damage control. It also questioned the extent to which warships should be designed to suit peacetime living instead of the needs of action in war, suggesting that recent designs had gone too far towards the former need, and emphasised the dangers of making arbitrary short-term economies during warship acquisition. The Defence Committee have been considering further the lessons of the Palklands campaign but have not yet reported.

3.3 With the exception of the Seabed Operations Vessel (SOV), a specialist one-off ship which has suffered from serious cost escalation and delay (see paras 3.15-3.18 below), shipbuilders’ performance in delivering FOC and subsequent ships has generally improved in recent years. NAO examination suggested however that as a result of problems referred to below, some ships have had to be delivered without some of their weapons, delaying full operational effectiveness, and there is some risk of delay with ships currently under development. On quality, MOD’s acceptance reports have generally been favourable to warshipbuilders. MOD are developing their acceptance procedures as indicated at paragraph 3.22 below. Overall the position is better than it was at the time of the earlier PAC examination.

3.4 MOD have pointed out that delays and cost increases have occurred principally in the planning stages before contracts for warshipbuilding were let and that changes to planning assumptions and targets related to In-Service Dates (ISD) and costs are inevitable as a project progresses through its various stages and what is achievable, what is required in terms of operational capability, and availability of resources become clearer. Delays arising for these reasons should be distinguished from those arising from difficulties in production.

Type 42 Destroyer 3.5 Improvements introduced by MOD as a result of problems encountered in development and production of the

early Type 42 destroyers, which were considered by PAC in 1975-76 (5th Report) and 1976-77 (4th Report), included the policy of early shipbuilder involvement, the prior assessment of shipbuilders’ capacity before inviting tenders and improvements in contract conditions. The Type 42 had been developed in the late 1960s under a “crash” programme, which resulted in the normal design period being halved, to provide a platform for the Sea Dart missile system as quickly as possible. It was found impossible to design the ship to existing naval standards within the cost limitations originally set and this resulted in a ship with no space and weight design margins for later modifications and modernisation. MOD recognised the limitations on later modernisation and the ship represented a compromise between what was desirable in a ship of this kind if viewed in isolation, and what could be afforded if the Fleet was to be cost-effective as a whole. Nevertheless a redesigned longer version was approved in 1977. The first of these is in service and the last three are due to be delivered in 1985. The stretched Type 42 (Batch III) programme was approved on the basis that at least five or six ships were necessary to achieve cost- effectiveness.

3.6 In 1981 a modernisation proposal was not pursued in view of the Defence Review requirement for a better balance of investment between platforms and weapons, a smaller surface fleet and suspension of major mid-life modernisation for frigates and destroyers which had previously allowed radical updating of weapons systems. This latter factor was of particular significance in view of the Type 42 design constraints. The 1982 Falklands conflict highlighted the recognised shortcomings. Short term improvements have since been introduced to remedy some deficiencies and a longer term weapons improvement programme to enhance capability of the 12 remaining Type 42s is under discussion. The space limitations in the early Type 42s have added to the difficulties and cost of making weapons systems improvements.

Type 23 Frigate 3.7 The 1981 Defence Review resulted in the decision to introduce as quickly as possible a new cheaper, less sophisticated frigate, the Type 23. The Type 22 programme was cur- tailed, although four vessels were later added to replace Falklands losses. Conceptual studies and initial feasibility studies were carried out by MOD but MOD’s efforts represent less than 15 per cent of the total Type 23 design work. Yarrow Shipbuilders Limited (YSL) were involved from an early stage and have responsibility for most of the detailed design. A proposal by Thornycroft Giles and Associates (the S90 design) was appraised but rejected as not conforming adequately to Naval Staff Requirements (NSR). Subsequen- tly some features of an alternative design by Y-ARD were incorporated in the Type 23 design.

3.8 Although it was originally intended that the Type 23 should be designed with export potential in mind, MOD found that a design with significant export potential would not meet RN requirements. They have informed me however that in the current Type 23 design some general purpose capability has been included, which provides some export

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potential, and that a number of countries have expressed interest. BS agree that the final specification has effectively excluded the ship from some export markets but see no fundamental reason why a frigate could not be designed for both the RN and for export. In particular they believe this could be done by designing a ship to accept modular weapons systems and to take advantage of the modular approach by choosing different weapon specifications to meet RN and overseas requirements.

3.9 Cost was a prime consideration leading to the introduction of the Type 23. The current estimated average United Production Cost (UPC) (005 million) for the first eight vessels represents a net real cost increase of 3 per cent over the 1982 NSR approval, which had increased by 16 per cent above the original target price due to decisions taken to improve operational capability. The estimated FOC costs are f44 million plus f72 million for the development of weapons unique to theType 23 (includingf28 million for the provision of a Shore Development Facility). Compared with the equivalent figures for earlier approvals, these represent a real cost increase of 18 per cent. The new vessel is still expected to cost about 20 per cent less than a Type 22 frigate. The 1981 estimated date of acceptance of the first vessel has slipped by about nine months; it was ordered from YSL in October 1984, and they expect to meet the contract delivery date.

3.10 MOD have told me that as a matter of policy target UPCs were set at specific stages to see what was achievable in terms of operational capability for a specific sum of money. Changes in the requirement to permit an increase in the capability at a specific cost were considered and authorised at a very high level and MOD regarded them as an example of good financial control. A major reason for the cost increases and delays is these improvements and modifications but other factors have also contributed.

(a) Equipment development problems - the Type 23 was originally intended to enter service with the EHlOl helicopter. However due to delays in the EHlOl programme and the Sea King helicopter remaining in service for some time after the Type 23 becomes operational, the Type 23 has been adapted to take the Sea King helicopter initially, requiring an increase of three metres in the vessel’s length in addition to cost increases. Significant problems have also been experienced in matching ship and weapon programmes; the weapons fit was not sufficiently defined in the early stages leading to delays in approving NSRs for the weapons. Problems might be experienced in supplying weapons system information to the shipbuilder in accordance with the dates stipulated in the ship contract. The development costs of the computer-aided command system have escalated and any further delays could jeopardize the integrating and proving of weapons systems on the Shore Devel- opment Facility.

(b) Shortages of design resources - MOD have informed me that the “knock-on” effect from design delays and late supply of weapons information, has resulted in an extension of the Type 23 design programme and may lead to further delay. Shortages at YSL have been assessed at about 15-20 per cent of

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design effort despite efforts made to sub-contract work. The design team was initially assessed by MOD as having adequate resources but delays occurred partly due to the necessary retention of design staff on Type 22 work. BS however do not consider it commer- cially sensible to employ sufficient design staff to meet peaks of demand and believe that it is more efficient and economical to smooth out the peaks and troughs, even if this sometimes means that the design teams cannot immediately meet every MOD demand. Never- theless YSL maintain that the detailed design work will be completed to a programme which is compatible with the current build programme and stress that they have design responsibility for this work and are con- tractually committed to its timely achievement. A shortage of intra-mural staff resources would raise the question whether they were adequate to exert effective control on both contractors and other MOD authorities but MOD have informed me there is no cause for concern about their own staff shortages in key positions.

(c) MOD believe the decision of BS not to support YSL’s plans for investment off 10 million in a module hall facility has contributed to delay in the Build Pro- gramme for Type 23 -01 and may have a more significant effect on subsequent orders. BSdo not agree, they believe the module hall would not significantly decrease frigate build times and that the main effect of building the hall would be to increase capacity within the industry when it suffers already from over capacity for steel surface ships.

3.11 In 1982 the Defence Committee expressed concern over the length of time taken over the early stages of the Type 23 programme. Whilst it is desirable for the production cycle including design to be as short as possible, previous experience illustrates the dangers of commencing production before design is fully defined, while cost benefits can result from a longer negotiating period, leading to a taut contract.

SSK 2400 Submarine 3.12 In the late 1970s MOD decided there was a role for a new diesel-electric powered submarine which for certain tasks was more cost-effective than a nuclear-powered submarine. After considering alternatives of a foreign buy or a collaborative project, MOD decided that UK design and build was the best option to meet the requirement, but only if the foreign sales potential was fully realised. The approved design, to which MOD are contributing less than 15 per cent of the total effort, with VSEL undertaking detailed design, is a compromise between Royal Navy and export requirements. MOD informed me that they are supporting VSEL’s export efforts to the extent of being willing to consider modifying the design of later vessels. However, BS believe that thedesignoftheSSK2400wasdictatedprimarilybyRN requirements and that the submarine could have been designed to be more attractive to the two other navies most likely to be interested.

3.13 By July 1984 ship FOC costs (U7 million) had increased in real terms by 20 per cent over the 1980 NSR approval but on the same basis the estimated UPC (f99 mil-

lion) had fallen slightly. The scheduled acceptance date for the first SSK 2400 has slipped by about 16 months compared with a 1978 target date. The reasons for delay included the fact that in contract negotiations, MOD were prepared to incur a programme delay in order to obtain an acceptable price. Some problems have occurred with development of new equipment hut MOD informed me that at present delays are containable within the build programme for SSK 01.

3.14 Unless VSEL sub-contracts a significant proportion of work on the hulls of submarines, the Trident programme may preclude them building the fourth and later SSK 2400s. Because of this and in accordance with MOD’s policy on competitive tendering, a joint MOD/BS working party was set up in 1982 to identify possible alternative shipbuilders after the FOC vessel. Three yards, two of whom have experience of submarine building, are competing against VSEL for follow-on submarines. Delays on long lead approvals and the need for competition have endangered the SSK 02 planned acceptance date by up to 6 months.

Seabed Operations Vessel (SOV) 3.15 The NSR in 1976 for the SOV called for a Saturation Diving System (SDS) with advanced capabilities. In many ways the ship and its weapon systems and the problems that arose are unique. I intend to provide PAC with further details of this project on a confidential basis. The main points are as follows:

(a) The project has suffered from significant cost escalation and delays. The latest estimated cost represents a real cost increase of about 17 per cent over the 1979 estimate, which already represented a real increase of 32 per cent over the 1976 approval. Although a mid-198 1 ISD was initially envisaged (ie in 1976), at the time the contracts were placed the Pro- gramme Acceptance Date (PAD) was end-1982. The ship was not accepted until July 1984.

(b) Major reasons for cost increases and delays have been underestimation of the complexity of the task; numerous design, mainly equipment, changes resulting from variations in Naval staff requirements largely linked to legislative changes affecting diving safety; difficulties in coordinating design and development when MOD, the ship contractor and three equipment contractors all had responsibility for various elements of the ship and equipments, with separate contracts between MOD and each contractor; staff shortages in MOD and at contractors: and major equipment defects which were attributable, in MODS view, to poor management, quality assurance and work- manship at contractors.

3.16 The SOV is a specialist one-off vessel but some points are relevant to warship building generally. MOD’s policy is to reduce the extent of direct oversight of contractors’ work (Naval overseers have fallen by 40 per cent since 1978-9; furthercutsareplanned)andrelyonthemmeetingapproved quality assurance standards. In this case the shipbuilders, Scott Lithgow (SL), used Lloyds Register to oversee sub- contractors’ work and MOD relied on them. This was not sufficient to ensure satisfactory performance. C of N, after reviewing problems with the wiring, concluded that delegation of design and production of complex ships or systems to

shipbuilders under fixed price conditions involved a risk of deficiencies in performance by contractors coming to light too late; and also stated that continuing difficulties in British shipbuilding made it unlikely that the risk would decrease in the future, given that the reduction in MOD staff numbers ensured there was no possibility of increased MOD control and oversight of such projects. C of N also concluded that the problems with SDS underlined the risks attached to development of FOC warships embodying facilities at the forefront of technical performance.

3.17 The current trend towards reduced oversight, arising partly from staff cuts, emphasises the need for effective quality assurance and for adequate contractual safeguards where standards are not met. Although MOD are generally satisfied with shipbuilders’ standards they recognise there is some way to go before all contractors achieve the required standards. MOD are currently exploring whether shipbuilders would be prepared to accept reliance on statutory common law rights in lieu of the customary one year guaran- tee on vessels and if so, whether this would be cost effective.

3.18 MOD are proceeding with SL in joint claims against sub-contractors in respect of faults in wiring installations; in the meantime MOD have a liability for the cost of defect rectification under an indemnity given in connection with the contract. MOD believe the cost to them would have been greater if no indemnity had been given and SL had taken an insurance themselves but they are considering the cost effectiveness of restricting the scope of the building risks indemnity given to shipbuilders in new contracts. The extent of MOD’s involvement in and responsibility for design was one factor in the decision not to pursue claims against main and sub-contractors in respect of the second major problem area, the SDS, although there were other considerations; overall substantial extra costs are likely to fall on MOD. This case illustrates the importance of responsibilities for design and liability for defects being clearly identifiable and that dispersal of responsibilities, which contributed to cost increases and delays, should be avoided where practicable.

Co-ordination of ship and weapons development 3.19 A MOD report in August 1982 reviewed the orgariis- ation and practices of SSC. In line with its recommendation to concentrate and increase the responsibility of project management of new warships, MOD are moving towards a total warship procurement concept whereby the Ship Pro- ject Manager has financial and technical progress responsibility for the whole ship including its weapons systems, although he is dependent on weapon project staff for the timely provision of his requirements. Weapons systems are normally not developed for just one ship and can be major projects in their own right. Classes of warship are also in future to be managed on a “cradle to grave” basis by the same project division. The joint ships weapons management teams for the SSK 2400 Submarine and the Type 23 Frigate projects are the first examples of this evolutionary process. There is evidence however that matching of ships and weapons development programmes will continue to be a formidable problem, which individual ship project man- agers will not be in a position to overcome without the assis- tance of senior management, other parts of MOD and industry.

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3.20 There has been, or may be, delay in bringing some ships, usually FOC vessels, to full operational effectiveness because of the problems in co-ordinating ship and weapons development. It is C of N’s declared aim that future warships should only incorporate equipments which have been fully developed before the warship design definition stage; but this involves a risk of ships not being equipped with the latest weapons and there would be pressure for the latter to be fitted. The change in aim requires a clearer definition of the relationship between future warship designs and their major equipments but must recognise the long timescales between the decision on weapon fit and the ship becoming operational.

3.21 MOD have informed me that the requirement is to get new weapon equipments to sea as early as possible; that a long-term warship planning unit recently established within SSC is considering the problem of coordinating ships and weapons development: and that there are encouraging signs that the problems are being solved for future projects. How- ever, currently problems in weapons development and integration and their relationship with other MOD systems could present difficulties in the appointment of whole ship prime contractors because of the potential problems in negotiating with and placing responsibility on the prime contractor.

Ship acceptance procedures 3.22 The final seal of approval on the acceptability of a new warship into the Fleet is provided by Commodore Naval Ships Acceptance (CNSA); his assessment of acceptability is based on work in two distinctly different areas, viz Design Acceptance of new weapons systems and Production Acceptance of new construction warships. For the former CNSA assesses the extent to which the Controllerate has satisfied the design contract placed with them in the form of theNSR; forthelatter CNSAassesses theextent to which the shipbuilder has satisfied the production contract. CNSA is extending the practice of design acceptance procedures into non-weapon areas to achieve a common approach across the whole ship. Following a feasibility trial on some non- weapon equipments incorporated in the SSK 2400 submarine and the Type 23 Frigate, CNSA concluded that non- weapons areas had been too imprecisely defined in the ship NSR or elsewhere as a basis for firm judgment on whether the completed ship should be accepted into the Fleet. MOD have informed me that their aim is not to have an over- precise definition of requirements in the ship NSR but, working on the ‘agreed characteristics’ principle, to develop standarised check lists for non-weapon equipments to form

a verifiable basis for subsequent acceptance by CNSA.

Adequacy of design resources 3.23 The Penny Report took the view that the total UK staff resources in warship design in 1983 (720 in MOD, 895 in industry) were no more than marginally adequate for all tasks; shortages were either being experienced or foreseen at two lead yards. Yarrows had a formidable task in managing the Type 23 Frigate design to programme and were undertaking some aspects of design work for which their previous experience was limited to relatively simple export ships. Their shortfall of design resources of 15-20 per cent below planned levels had been exacerbated in the requiremen% for parallel work on the redesign of the Type 22 Frigate and design of the Type 23. Delay in the Type 23 programme due to lack of weapon information alleviated this situation but MOD have more recently expressed concern at the shortfall. At VSEL the slow build up of resources for the design of two submarine projects has been crucial; there were insufficient design resources to pursue more than one option for the new SSK which had to be designed during the period available before the hulk of the effort on the Trident Submarine was required. Generally there are insufficient resources for competition in design and MOD have informed me that quality of design resources in the shipyards was also a cause for concern. However BS disagree and as stated at paragraph 3.10b believe it would not be sensible for them to employ sufficient staff to cope with peaks of demand.

3.24 Increasing pressures on intra-mural staff resources and concern that essential tasks, eg Type 23 frigate, may not be completed on time, have led MOD to consider contracting out tasks traditionally performed in-house, eg post- design work for steam powered frigates, and some work of the Chief Naval Architect. These proposals are under consideration along with alternative ways of achieving required cuts in staff numbers in SSC and pending further cost appraisal.

3.25 MOD told me that although they have an important role in the consideration of overall design resources, ie both in MOD and in industry, they are not in a position to control all of them; also that NSRs take into account the availability of resources and MOD assess shipyard capacities before placing production orders. As the only customer for warships in the UK, MOD have an important interest in ensuring that adequate national design resources are available and that they are deployed in the right areas to meet future national needs. The new long-term warship planning unit (paragraph 3.21) should have an important future role in this area, although its influence is limited at present.

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Part 4: Performance of Warshipbuilders

Performance and productivity 4.1 On average, warships, including FOC ships, were delivered 19 months later prior to 1977 whereas they were on aveiage delivered on time from 1977 to 1983. However the Ministry have informed me that factors other than the devolving of responsibilities to industry have played their part; viz industrial peace, mild winter weather, the benefits of series production and adequate industrial capacity arising mainly from lack of export orders and of merchant work. BS consider that the effect of some of these factors has been no more than marginal and that improved management, together with significant capital expenditureat YSL, Vesper Thornycroft (VT) and Swan Hunter Shipbuilders (SHS) has played its part. This does nevertheless represent a significant improvement in the delivery performance, although MOD have informed me that this situation may not be sustained if factors such as those referred to change. However the NAO’s examination indicated that the position has been less satisfactory on costs and productivity.

4.2 It is difficult to make valid comparisons with the productivity of foreign warshipbuilders because different circumstances apply and relevant information is not available, but there is a weight of opinion and evidence that productivity in UK warship yards leaves room for considerable improvement.

(a) In 1979 PAC (6th Report 1978-79) considered evidence of declining productivity in the construction of Nuclear Fleet Submarines and recommended that earnest consideration be given to means of measuring and stimulating performance levels of the few firms engaged in warshipbuilding. Treasury Minute dated 2 August 1979 (Cmnd 7631) accepted the need for a major improvement in productivity and stated that BS had undertaken to study and discuss with MOD ways of measuring and stimulating the levels of performance of warshipbuilders. BS claimed, although MOD did not accept, that productivity at VSEL, the monopoly supplier of nuclear submarines for the Royal Navy, had declined during the 1970s and they pro- duced a paper setting out the actions which had been taken to initiate measures to identify the problems and to raise the productivity of all the shipyards. Following discussions between MOD and BS, a note was prepared by BS in January 1980 on “Improving performance. and cutting costs in warshipbuilding”. They reported that each company had developed a Pro- ductivity Improveinent Programme (PIP); that significant potential for improving the work rate existed; that a productivity improvement of up to 25 per cent plus a reduction in build times was necessary to maintain a competitive position in the export market; and that a 25 per cent improvement by March 1985 would be the basis of Corporate planning, although individual yards were reasonably expected to improve on the targets and individual PIPS would contain more ambi- tious objectives.

(b) InevidencetotheIndustryandTradeCommittee in 1981 the Minister of State for Industry suggested that productivity had not always matched the best else-

where; no major warship export had been achieved since 1973. The lack of export orders cannot be attributed solely to lack of UK productivity but a review by the Defence Sales Organization in 1981 drew comments from UKshipbuildcrsthatproductivitywas poor; some overseas competitors obtained as much as 50 per cent more productive man hours per day. In a wider context evidence from the Department of Trade and Industry in 1984 pointed to much higher UK merchant shipbuilding labour costsper Unit of Output compared with overseas competitors.

4.3 BS have stated that significant capital expenditure at some yards has helped to improve productivity and a major capital investment, supported by Government loans, to modernise submarine building facilities at VSEL at a cost of f200 million was approved in 1982. The main part of this investment was authorised so that VSEL might remain a modern submarine builder, able to build the Trident submarine. The balance was justified mainly on the grounds of expected improvements in productivity and an overall improvement of 17 per cent by 1991-2 was assumed. The shipbuilders have also taken steps to improve productivity by providing for this in annual wage settlements. In 198 1 BS informed MOD that the value added bonus schemes introduced in 1979 had assisted in stemming the decline of productivity in the warship yards. The 1983-84 agreement ending some restrictive practices is expected to produce major improvements. BS have also been considering the need for major changes in construction techniques involving the use of modern assembly methods to improve competi- tiveness. It is too soon to judge the effects of these latest measures. MOD informed me that the target of a 25 per cent improvement in labour productivity by March 1985 was not being achieved; but YSL and VT had achieved improvements and VSEL had stated that from 1979 to 3 1 March 1984 productivity at Barrow had increased. BS have stated that there have been real improvements on some programmes and pointed out that the most significant reductions in man hours and improvements in productivity have taken place on the only programme, at VT, where series production has been possible as a result of batch ordering by MOD.

MOD influence on performance and productivity 4.4 The warshipbuilders depend on continuing orders from MOD. Although their order book has fallen from 40 warships in 1977 to 28 in June 1984, including 24 from MOD, a greater proportion of the turnover at the 5 main yards is attributable to payments from MOD, increasing from 57 per cent to 72 per cent between 1979 and 1983, largely due to the yards’ withdrawal from the merchant market and the shortage of export work; export orders achieved have been for smaller vessels. Cmnd 8288 in 1981 announced reductions in destroyer/frigate force levels. All five yards capable of building major warships are now almost entirely dependent on MOD orders following the withdrawal of SHS and Cammell Laird (CL) from merchant and off-shore work respectively. VSEL, YSL and VT provide lead yard services. These three yards also construct

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FOC vessels and SHS hopes to construct the AOR FOC. VT also have some export work.

4.5 Following consideration by PAC of contracts with VSEL for Type 42 destroyers (4th Report 1976-77). Trea- sury Minute dated 14 November 1977 (Cmnd 6977) stated that MOD would maintain acontinuingdialogue with BS on matters such as future ordering strategy, productivity and efficiency. Changes in MOD’s requirements in the past have not been conducive to efficient planning by the shipbuilders. MOD have informed me that prior to June 1981 there were discussions with BS at Board level at which BS were provided with an indication of MOD’s likely requirements, but without commitment. Such regular discussions have not taken place since 1981. MOD also informed me that although in a competitive situation they were unable to give any indication of where orders might be placed, broad indications of likely ordering patterns had been given.

4.6 As stated in paragraph 4.2(a) above, following further consideration by PAC of declining productivity in warship construction and the issue of Cmnd 763 1 in August 1979, BS forwarded to MOD in January 1980 a note indicating that a 25 per cent improvement in productivity was required. The NAO were assured by MOD that close contact had been maintained with the shipbuilders since 1979 through a number of avenues; that improvements in productivity had been pursued in consultation with BS and individual shipbuilders and in the context of individual contracts; and that MOD sought to influence performance by taking account of earlier contracts information in negotiation and subsequently monitoring progress against milestones. In May 1984 BS gave a presentation to MOD on their current plans to improve productivity.

4.7 The NAO examination showed that although they have suffered in negotiation from a lack of reliable, up-to- date and comprehensive information on productivity gains, generally MOD have taken action in the last few years which should stimulate improvements in warshipbuilders’ performance and productivity. In addition to putting more emphasis on competition for both main and sub-contracts, they have since 1982 been trying to provide for improved productivity in contracts. Recent contracts for submarines and frigates have included incentives for significant improvements in labour productivity above current levels, incorporating reductions in man hours to cover future improvements.

4.8 The position of VSEL is particularly important because they are the monopoly supplier of nuclear submarines for the Royal Navy. In turn VSEL are currently entirely dependent upon MOD orders. As indicated in earlier paragraphs, BS claimed that productivity at VSEL declined during the 1970s (paragraph 4.2a); a major capital investment scheme expected to improve productivity has been approved (paragraph 4.3); the company’s 1981 Per- formance Plan envisaged a 25 per cent labour productivity improvement by I986 but to date improvements overall have been below target and there are indications to suggest that productivity may have fallen since the 1983-84 agreement (paragraph 4.3). However contract prices for the latest nuclear and SSK submarines anticipate the achievement of

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future productivity and performance targets in addition to improvements achieved since previous contracts were placed.

4.9 As a customer upon whom the warshipbuilding yards depend for so much of their business, MOD should be in a strong position to influence performance and productivity. They can continue to pursue the use of contractual measures as a means of influencing performance, including tough negotiating on build hours based on improved levels of productivity. BS however, while accepting that some criticism of the yards performance is justified, consider that the fundamental questions of competition, capacity and batch ordering are of considerably greater importance than the contractual process in determining whether the Government is getting value for money in its warship procurement and that the latter might also be achieved in other ways, eg by introducing exportable designs.

(a) Competition and capacity In 1973 MOD announced that their policy would be to keep the three specialist warship yards fully loaded and that opportunities for competition would be severely reduced. Progress achieved in warship construction under this policy was regarded by MOD as disappoint- ing because of under-estimation by shipbuilders of the difficulties of building complex modern warships, low productivity and shortages in certain key trades. In 1982 a joint MOD/BS working party concluded that future RN orders would only be sufficient to keep two of the specialist warshipbuilders in business but subsequently orders were increased to replace losses in the Falklands campaign. In recent years MOD have used competition for follow-on vessels after the FOC and can continue this means of influencing performance and productivity. This does however require an element of over capacity which currently exists but will not necessarily remain in the UK after privatisation, although foreign competition may be possible in some cases. I note however that the maintenance of a competitive base for warship construction was accepted by Ministers as a prime aim of privatisation and was also recommended by Mr Levene (paragraph 1.6 and Appendix). At various times in the past MOD have pursued a policy of allocating orders to yards and a further recent example has occurred with the decision on orders for Type 22 Frigates referred to at paragraph 4.10 below.

(b) Batch ordering BS regard batch ordering as the ordering of 3 or more ships at the same time. They have drawn attention to the fact that the most significant recent reductions in man hours and improvements in productivity have taken place at VT where the only example of series production has occurred (paragraph 4.3). They regard this as evidence of the cost savings that could be achieved if MOD were to move to batch ordering. They also consider that batch ordering would provide a justification for further capital investment such as the proposed module hall at YSL (paragraph 3.10~) and lead to lower prices; capital investment without batch ordering would just increase an already surplus capacity. MOD recognise the potential benefits to themselves from batch ordering but historically have

found it difficult to create the right conditions for its implementation. MOD’s long term ships programme is not a firm commitment to place orders and operational, budgetary and other factors can lead to changes in requirements.

(c) Exportable designs Obtaining export orders for major warships should result in lower unit costs and prices to MOD. The lack of export orders cannot be attributed solely to poor UK productivity; the Penny Report concluded that political and financial factors (credit arrangements as well as pricing) and the availability of secondhand ships from the US and USSR were also significant. However BS believe the main reason is that ships have not been designed with a view to achieving export sales. MOD have stated that export sale potential is kept in mind at all stages of the procurement process. BS however believe more could be done (see paragraphs 3.8 and 3.12) and that those countries which have successfully exported have deliberately designed smaller frigates or large corvettes and that their designs offered easier modular weapons fit.

(d) Dialogue with warshipbuilders MOD could influence efficiency by providing information on future requirements to facilitate shipbuilders forward planning; prior to mid 1981 they did this regularly, although without commitment because of the factors referred to at the end of paragraph 4.9(b). There has been no recent dialogue at corporate level and MOD would in any case have to make alternative arrangements when the individual yards are probably each under different ownership following privatisation.

4.10 The potential problems of competition and capacity and the possible savings from batch ordering are illustrated by the recent case of the orders for Type 22 and 23 frigates. On 28 January 1985 the Secretary of State announced that an order for one Type 22 frigate would be placed with CL and an order for a second with SHS, although the cheapest solution would be to place the order for both ships with one yard. This decision took account of the wider relevant factors involved and offered the prospect of survival of CL as a major warshipbuilder. He also announced that he had decided to negotiate an order for the second Type 23 frigate at SHS as soon as this could sensibly be done and subject to satisfactory agreement on price and other contract terms. The Secretary of State said that he expected the price for this frigate to reflect the economies obtainable with an order for . two frigates rather than one: and to be competitive. In order to establish this, tenders would be invited for the third Type 23 order in the same timescale from all UK yards capable of

* carrying out the work.

4.11 It was recognised when these decisions were taken by the Government that other extra costs to public funds might

arise in the longer term as a result of the decision to support CL, taking into account the effects on the prospects for privatisation of the warship yards, and some of these would fall on the Defence Budget. MOD believe that there will also be offsetting savings and that the net effect would be difficult to determine.

4.12 The decision by the Government to procure the two Type 22 frigates other than by the cheapest solution appar- ently conflicts with the general policy objective pursued by MOD in recent years of seeking to achieve better value for money in the acquisition of warships by the maximum use of competition. However MOD have explained that they also seek to ensure that there is enough capacity in the industry to permit competition. The decision to procure the second Type 23 frigate without full and effective competition is also a departure from recent MOD policy for the ordering of follow-on vessels.

4.13 This case also provides evidence that BS placed some limitations on the extent of competition between their subsi- diaries; MOD judge that competition for the Type 22 frigate orders was not fully effective over the whole range of the prices as each tender included at BS’s direction a common and high rate of profit. They calculated that if the appropriate Government profit formula rates for non-competitive contracts had been used for the Type 22 tenders, the price of the order could have been considerably lower. However BS have pointed out that it was unrealistic to assume costs included in a non-competitive tender would have been the same and that the reduced profit percentage would have accompanied a lower risk to the shipyard; also that they felt it inappropriate, as a public sector holding company, to allow any one yard to win a contract by accepting a lower return to shareholders than other yards. The yards tendered fully competitively on labour, materials and all other costs.

4.14 It is important that the right balance is maintained between demand and capacity. Some overcapacity is needed to provide scope for export work and competition, both of which can help to improve efficiency and reduce costs, but this has to be offset against the cost of maintaining that capacity. DTI and BS have questioned whether the present degree of over capacity is required and it is clear, as indicated in paragraph 4.9, that they on the one hand and MOD on the other have different views on the best means of obtaining value for money in warshipbuilding. Decisions on design and orders must rest with MOD and have to take account of operational priorities and the practical problems involved in entering into forward commitments. There seems however to be a need for a greater dialogue at a high level between all the interested parties, both before and after privatisation, than has been the case in recent years so that the potential improvements and benefits identified by warshipbuilders are properly appraised and fully taken into account by MOD in determining policy and in taking decisions on design and current and future orders.

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Part 5: Negotiation of Warship Contracts

Profitability of warship work 5.1 Since 1980-81 BS has reported warshipbuilding profits of fl85 million. During the same period the remainder of BS made losses of f525 million.

5.2 The main warshipyards undertake a range of competitive and non-competitive contracts, the commercial risk on the latter usually being shared with MOD. The Profit Formula for Non-Competitive Government Contracts has allowed, on a weighted average basis, target profits of about 9 per cent on cost to be earned by the 5 main warship yards on non-competitivecontracts between 1980and 1983. Total profits on warship work in these yards, as shown in BS accounts, were more than 11 per cent on cost in the same period. Neither MOD nor BS regard these profits as excessive, since they included profits on a number of MOD competitive contracts and a small amount of export work. However I note that more than 70 per cent by value of MOD work during this period was placed on a non-competitive basis and as I noted in my recent report on the Profit Formula (HC 243, paragraph 6(a)), the target rate of profit has itself remained at a relatively high level in recent years.

Negotiation of contracts: 5.3 The major starting point for non-competitive warshipbuilding contracts negotiations is the agreement between MOD and the contractor on the estimated main build hours required to construct the vessel. While there is evidence that productivity has not been high, the main warshipbuilders have consistently underrun estimated main build hours on MOD non-competitive contracts and in some cases earned the maximum profits allowed; this throws doubt on the accuracy of the estimates of labour input on which pricing was largely based, although other factors such as improvements in productivity and the cost of achieving them, the extent of sub-contracting, early delivery, industrial relations and build methods are also relevant. MOD have pointed out that where fixed price incentive fee contracts operate, any underrun results in a reduction in price to MOD in addition to increased profit for the warshipbuilder.

5.4 The NAO found that in 19 out of a sample 22 major warships ordered since 1973 and completed or near comple- tion (mostly non-competitive risk type contracts) agreed estimates (main build hours) were greater than the actual or latest forecast outturn by an average 15 per cent. Of 43 warships ordered since l973,25 were accepted between 1979 and 1984, l’lofthesebytheendof 1982, but only6havebeen finally priced; 4 of these plus 2 others ordered earlier have been post costed. These included 4 Type 22 frigate contracts on which MOD subsequently negotiated some f 12 million price reductions from YSL to take account of over- estimating. In some other cases maximum price or maximum profit provisions have limited MOD’s liability. Delays in final pricing are due partly to staff shortages.

5.5 The contract analysis referred to above indicated that in the period 1975 to 1981 MOD’s own estimates of build hours required were more accurate than contractors’ tender estimates. MOD estimates averaged some 110 per cent of outturn, contractors’ estimates averaged 121 per cent, while

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the negotiated contracts figures exceeded outturn by 15 per cent. Post costing reports for early Type 22s and aircraft carrier CVS-01 confirmed over-estimation of work content and MOD concluded that there had been weaknesses in technical costing capability (within MOD) on Type 22 estimating in 1979. MOD have suggested however that a fairer comparison would be in terms of labour costs since these reflect not only the number of man hours included in negotiated contract figures and outturns but also the cost to the shipbuilder of those man hours, including the cost of any value added bonus payments made to the workforce. On this basis MOD calculated that negotiated labour costs in the above analysis exceeded outturn costs by an average of about 10 per cent.

5.6 Variations between estimates of build hours have been particularly marked in the case of VSEL, with differences between MOD’s and VSEL’s initial estimates for six vessels included in the sample averaging 21 per cent, in the worst case 43 per cent: MOD’s estimates were the more accurate but negotiations generally led to a considerable move towards the contractor’s estimates. During recent SSK 2400 negotiations MOD noted that VSEL had consistently over- estimated the man hours required for nuclear submarines and aircraft carriers; the only time in recent years that their outturn had been close to contract was on one Type 42 contract where MOD had been able to stand firm at the contract stage because there were figures available from other shipyards. The Principal Director of Contracts (Navy) has commented that, looking back over the results of earlier contracts with VSEL, it would seem that MOD had been too easily persuaded towards the company’s view of manpower requirements.

5.7 TheNAO received evidencein thecourseoftheinvesti- gation that MOD negotiating teams have suffered by comparison with better supported shipbuilders’ teams, particularly in respect of cost and estimating issues, although MOD have the advantage of information from other shipbuilders. Difficulties resulting from poor information on productivity have been referred to at paragraph 4.7. However the position has improved in the last few years as indicated below.

Improvements and current developments 5.8 MOD have taken action in the last few years to improve the situation outlined above. In particular, as stated in part 4 they have put more emphasis on competition including competition for sub-contracted supplies, as in the Type 23 Project where some 76 per cent by value of sub- contracts and supplies will be purchased by competition. The emphasis on competitive tendering wherever possible has resulted in lower prices for some ships. There wiJl be fewer major non-competitive contracts in future other than for nuclear submarines but these are expected to be worth morethanU,OOOmillionupto 1990. MODhavetoldmethat there will be substantial competitive sub-contracting within this total but the position at VSEL is nevertheless particularly important.

5.9 In non-competitive contracts MOD must rely on stringent estimates and contract conditions which also give incentives to the supplier. There have been moves to strengthen contract conditions in recent years including replacement of some unsatisfactory conditions; reduction of the provisionally priced proportion of contract prices, especially on nuclear submarines, and improvements in the Ministry’s share of cost under-runs; further tightening of contract conditions is being sought in individual contract negotiations. To some extent these improvements can be nullified if estimated build hours are over generous. There

. is, however, evidence of tougher negotiating by MOD and instructions now emphasise cost above programme dates, a reversal of earlier practice. All these changes and the provision in contracts for improved productivity should have a

significant effect on performance and the achievement of improved value for money but it is still too early to assess the outcome.

5.10 MOD have pointed out to me that the drive towards negotiating tauter contract terms in the past two to three years has been emphasised by top management and Minis- ters; there is now a greater emphasis on cost rather than meeting programme requirements but there could be a price to pay in delayed operational capability; they have also pointed to a move from fixed price incentive fee type contracts to fixed pricecontracts for later follow-on surfaceves- sels, indicating a greater confidence in the accuracy of the estimates.

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Glossary of Abbreviations

AOR

ATS

BS

CL

CNSA

CofN

DCW

DTI

FOC

ISD

MOD

NAO

NSR

NST

PAC

PAD

PIP

RN

SDS

Secretary of State

SHS

SL

sov

ssc

UPC

VT

YSL

VSEL

Auxiliary Oiler Replenishment

Aviation Training Ship

British Shipbuilders

Cammell Laird

Commodore Naval Ships Acceptance

Controller of Navy

Deputy Controller Warships

Department of Trade and Industry

First of Class

In Service Date

Ministry of Defence

National Audit Office

Naval Staff Requirement

Naval Staff Target

Public Accounts Committee

Programme Acceptance Date

Productivity Improvement Programme

Royal Navy

Saturation Diving System

Secretary of State for Defence

Swan Hunter Shipbuilders Ltd

Scott Lithgow

Seabed Operations Vessel

Sea Systems Controllerate

Unit Production Cost

Vesper Thornycroft

Yarrow Shipbuilders Ltd

Vickers Shipbuilding Engineering Ltd

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Appendix

Mr Peter Levene’s report on warship procurement: Recommendations and Controller of the Navy’s comments

(a) Apply, without reservation, my (Mr Levene’s) wider recommendations, set out at paragraph 56 of the report on Equipping the Armed Forces, to the warship procurement process; in particular acquire the right people with the right approach.

(These recommendations will be referred to in my (C&AG’s) forthcoming report on Production Costs of Defence Equipment.)

(b) Encourage the maintenance of a competitive base for warship construction.

C of N commented. that the degree of competition at prime contractor level would always be limited to a small number of yards and there was no immediate prospect of competition for the construction of nuclear powered submarines.

(c) Seek to establish sufficient extra-mural design agencies to produce competition at the stage of Detailed Design.

C of N commented that this was very attractive but not realistic because of infrequent demand even if manpower could be found. MOD therefore had to rely on the lead yard concept. Paying 2 or more agencies for detailed design would also be expensive.

(d) Develop the role of major weapons companies as prime contractors, with the longer term aim of enabling them to compete as suppliers of major warships.

C of N commented that this was in line with current policy but what was achieved would depend ulti- mately on the willingness of weapons contractors to become involved and on the shipyards.

(e) Examine the scope for increasing the Warshipbuilding Industry’s statutory liability for its product.

C of N agreed but pointed out that firms had shown a reluctance to innovate and MOD were moving ahead of a pretty conservative industry.

(f) Draw up procedural guidelines which will impose greater discipline on design change during build.

C of N accepted the need for close control of design changes during build but felt that procedures were already very tight. Some design changes during FOC build were however necessary because this was the nearest equivalent to a prototype and MOD had to make the best use of rare opportunities.

(g) Press ahead with the ‘New Look’ philosophy to achieve total integration of ship and weapon staffs.

C of N commented that separate weapons staff would be necessary in some circumstances, ie for free-standing projects such as torpedoes; where MOD funded development; and where several warship projects were involved.

(h) Establish, as a matter of priority, Information Technology links between sites in the warship procurement and equipment process.

C of N agreed that better communications were needed.

(i) Ensure that in-house effort is reduced to match the transfer of functions to Industry, to avoid duplication, and to make the most cost-effective use of administrative resources.

C of N commented that although the Controllerate would continue to reduce, MOD must be careful not to go so fast that it gave up essential tasks and safeguards before industry was ready to take them on and at a price MOD could afford.

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ministry of defence design and procurement of warships

Documents