MOD: Major Projects Report 2003 (HC 383-i) Public Accounts Committee 23 Feb 2004

Evidence given by Sir Kevin Tebbit KCB CMG, Permanent Under-Secretary of State, Sir Peter Spencer KCB, Chief of Defence Procurement and Lieutenant General Rob Fulton, Deputy Chief of Defence Staff for Equipment Capability, Ministry of Defence, and Mr Mike Turner CBE, Chief Executive, BAE Systems plc, examined.

Q27 Mr. Gerry Steinberg (City of Durham): One gets the impression reading the Report, Sir Kevin, that the previous government went into these contracts completely with its eyes closed and we now see the consequences of their actions. On the other hand if we read the Report carefully I would make the point, and we do not make critical points in this Committee if we can help it, this Government seems to be going into major contracts with its eyes closed, so nothing seems to have changed much. The only thing I can put it down to is they must get some dreadful advice from civil servants like yourself, why do they make so many mistakes?

Sir Kevin Tebbit: I do not think we do make quite so many mistakes. The four programmes that you are looking at, the four legacy programmes, they have caused a 6.1% increase in the total forecast cost of overall major projects, which will be incurred over a number of years. That is very disturbing for me because I have a budget which is growing by 5% over three years and clearly this cannot go on uncontrolled. What we have seen here is a reversal of what had been a very good trend for the last five years of reduction in the cost increase of our programmes. I take it very seriously. I am encouraged firstly by the knowledge that it is mainly to do with these four programmes, it is not to do with the whole population. I would submit to you, you can see it in the Report itself, for the newer projects, the so-called Smart projects, performance is much better by whatever measure you care to apply.

Q28 Mr. Gerry Steinberg (City of Durham): The programmes we are talking about are basically legacy programmes and the Nimrod Programme is a prime example of what I mean, the perfect example. The contract has been negotiated from its original agreement three times simply, as I read the Report, because BAE could not deliver what they were signing to deliver so the taxpayer has to pick up the Bill because BAE cannot deliver. Am I interpreting that correctly or not?

Mr Turner: BAE, now BAE Systems took the contract in the mid-90s which it clearly should not have done, it was the wrong contract but for strategic reasons, I remember at the time, we believed in order to keep continuity of the defence resources in the United Kingdom before we got on to the Typhoon and what is now the JSF Programme, it was a good idea at the time. We had a monopsony who said, "if you want to do business these are the terms in which we do business", we had no alternative, we wanted to keep our resources in place for the long term and we took that contract.

Q29 Mr. Gerry Steinberg (City of Durham): You took a contract that you could not deliver, is that what you are saying?

Mr Turner: No. At the time the board was convinced - I was on the board but I was not responsible for this programme - a presentation was made to the board by the programme management team, even though no de-risking had been done - less than 1% was spent on de-risking and Smart Acquisition says 15% - with the contract beforehand. We were persuaded that this would be a profitable contract.

Q30 Mr. Gerry Steinberg (City of Durham): By whom?

Mr Turner: By the project management team.

Q31 Mr. Gerry Steinberg (City of Durham): In your company?

Mr Turner: In my company. We were wrong. When the MoD wanted to change the nature of the Nimrod specification and performance to make it more command and control and make it launch smart weapons report we had a negotiation with MoD to re-negotiate the price and that is what we have done.

Q32 Mr. Gerry Steinberg (City of Durham): Why is it that you took a contract that you now admit that you should not have taken in the first place, why is it that the taxpayer loses out and not BAE?

Mr Turner: We have lost. I am afraid our shareholders have lost £1 billion in total on both Astute and Nimrod, most of it is on Nimrod, and that is a very, very heavy price to pay.

Q33 Mr. Gerry Steinberg (City of Durham): The Government has lost £1 billion and three aircraft.

Mr Turner: I do not follow the numbers that way.

Q34 Mr. Gerry Steinberg (City of Durham): It says so in the Report.

Mr Turner: There are costs of capital issues in there which I do not fully understand. At the end of the day the Armed Forces of the United Kingdom will get a very, very efficient system which is far cheaper than you will get anywhere else in the world. I might also say in the MoD's defence while the Report says about 6% overspend on all of the programmes in here, if you look at the equivalent in the United States it is over 20%. Whilst we have room for improvement we are still better than the United States.

Q35 Mr. Gerry Steinberg (City of Durham): We are not here to investigate the United States, we have a bad enough job investigating ourselves. The taxpayer, as I read the Report, I may well be wrong, has lost £1 billion and three aircraft out of this deal. BAE have not lost a great deal, Mr Turner is telling us they have lost £1 billion as well?

Sir Kevin Tebbit: The payments to industry are £303 million, we have paid £10 million for additional capability, which is the area that was being discussed, by converting aircraft for more general use, and the interest on capital there is £225 million, that is to say internal accounting arrangements, which covers the time delay, so the figures are lower than that. That does not mean to say that it is not serious.

Q36 Mr. Gerry Steinberg (City of Durham): You also lost three aircraft because you agreed to build three aircraft less in the contract?

Sir Kevin Tebbit: Yes, indeed, from 21 to 18.

Q37 Mr. Gerry Steinberg (City of Durham): What are three aircraft valued at?

Sir Kevin Tebbit: Until we price the aircraft I cannot tell you, we have not specifically priced them yet.

Q38 Mr. Gerry Steinberg (City of Durham): Come on, what do they cost, £1 million each, £100 million each or £50 million each? You buy the bloody things, come on, how much does an aircraft cost?

Sir Peter Spencer: In terms of straightforward unit production cost the target cost at the moment is between £53 million and £60 million.

Q39 Chairman: We have lost £180 million worth of aircraft in the re-negotiating of the deal.

Sir Peter Spencer: In terms of living inside the budget that was one of the measures which was taken.

Q40 Mr. Gerry Steinberg (City of Durham): We have lost just under £1 billion in capital and revenues and we have lost three aircraft valued at about £150 million. That is not a bad deal for BAE. The Chairman made a point which you denied, the chairman inferred that Sir Raymond Lygo said that they would take on a contract because they simply know that at the end of the day they have the Ministry of Defence by the proverbials and they are going to have to pay regardless of what happens. That is true. You know that if things go wrong the taxpayer is going to pick up the bill and in this case the taxpayer picked up something like £1 billion, plus three aircraft valued at £150 million, that is not bad.

Mr Turner: Mr Steinberg, it cost our shareholders £800 million on Nimrod.

Q41 Mr. Gerry Steinberg (City of Durham): You took the contract in the first place, nobody forced you to, Mr Tebbit did not come along with a gun and say, "You have to take this contract".

Mr Turner: We took it. That is why we had to take what I call the medicine of £800 million for our shareholders.

Q42 Mr. Gerry Steinberg (City of Durham): Why should I and everybody sitting in this room who pay their taxes basically pay your company a subsidy of £1.2 billion because you made a mistake?

Mr Turner: The mistake has cost our shareholders £800 million. The taxpayer will still get value for money.

Sir Kevin Tebbit: Mr Steinberg, the figures are not as large as the ones you suggested but I do take your point in general. The reason we did not enforce the contract is the real point, the reason we did not enforce the contract is because we accepted that the damage that this was doing to the company was such that we had to take cognisance of it. If we carried on as we were there was a real risk that we would not have got the capability at all. Why should the company continue to spend a fortune and keep producing to meet the contract when they have a responsibility to their shareholders, we had to take into account the company's position, we do have a defence industrial policy, we have something like £37/38 billion worth of business over a very long period of years into the future with BAE Systems. We had to take into account our own need of this capability. We judged that from where we were last year that proceeding to re-negotiate the contract with incentives and tighter arrangements in it was the best value for money in the circumstances.

Mr. Gerry Steinberg (City of Durham): You know I have a time limit, I do not want to be rude.

Chairman: He does not want to be rude to you!

Q43 Mr. Gerry Steinberg (City of Durham): Sir Andrew Turnbull said that I was not to be rude to you. Could we move on, you read the Report and you see long overruns, extra costs and being forced to take actual weapons that we do not even want because the company will not re-negotiate. Here the company are making mistakes, the Department are making mistakes, everybody is making mistakes and here we are we have to now accept a weapon that we do not even want, it is going to be put into storage, left in storage or you might be able to sell it to somebody else who may use it at a later date.

Sir Peter Spencer: I think there is a misunderstanding.

Q44 Mr. Gerry Steinberg (City of Durham): It is in the Report. I said this last week, we read different reports, you get a different report to us, I am sure you do.

Sir Peter Spencer: Can I finish?

Q45 Mr. Gerry Steinberg (City of Durham): Let us hope that we are reading the same Report, Sir Peter.

Sir Peter Spencer: If you look at the breakdown of the cost overrun of Brimstone you will find that the large majority is interest on capital because the programme has been extended by the MoD twice by periods of 12 months, the first to align the weapon programme with the aircraft programme and secondly during the course of last year's operations in Iraq and prior to that the requirement was deemed to be more important to get Storm Shadow fitted ahead of time so that could be deployed operationally. These weapons will still be extremely useful, there was in the light of -

Q46 Mr. Gerry Steinberg (City of Durham): These weapons could be extremely useful!

Sir Peter Spencer: I said "will be". We have had a very successful series of firings, the weapon out-performs its spec and it will be brought into service as soon as we are able to.

Q47 Mr. Gerry Steinberg (City of Durham): Do you have more than you want, is the Report correct there?

Sir Peter Spencer: There was a judgement made that with the benefit of hindsight we would have bought a smaller number of weapons than we originally contracted for. We were unable to agree terms with the company acceptable to us and to the taxpayer on which they would take them back.

Q48 Mr. Gerry Steinberg (City of Durham): It is not acceptable to say that we have got some weapons that may be useful.

Sir Peter Spencer: Will be useful.

Q49 Mr. Gerry Steinberg (City of Durham): In hindsight we ordered too many, it is with the taxpayers' money you are ordering too many.

Sir Peter Spencer: If you look at the time this order was taken you would had to have had the gift of foresight to know about changes in operational circumstances. These days we go for a more incremental form of acquisition. In the context of whether or not we have the right number as of today's judgement of operational circumstances with the benefit of hindsight we would have bought a few less. Unable to get the company to agree to take them back we have put them back into our costings.

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Q171 Mr. Gerry Steinberg (City of Durham): Mr Turner, you talk about how your shareholders have been subsidising the taxpayer. How many dividends have you paid out since you took over the contracts?

Mr Turner: On the back of making money on 80% of our business that is not MoD we have been paying dividends, yes.

Q172 Mr. Gerry Steinberg (City of Durham): How many have you paid out over that period?

Mr Turner: What do you mean, how many? We pay them twice a year.

Q173 Mr. Gerry Steinberg (City of Durham): How much each time?

Mr Turner: Last year it was about nine pence.

Q174 Mr. Gerry Steinberg (City of Durham): Nine pence on a share?

Mr Turner: Nine pence per share.

Q175 Mr. Gerry Steinberg (City of Durham): Total overrun costs are about £5 billion, is that right, or just less than £5 billion?

Sir Kevin Tebbit: On the Major Projects report?

Q176 Mr. Gerry Steinberg (City of Durham): Yes.

Sir Kevin Tebbit: In-year it is an extra £3 billion, which is 6% of the total cost of the overall Major Projects group.

Q177 Mr. Gerry Steinberg (City of Durham): So £3 billion?

Sir Kevin Tebbit: Yes, of which 42%, just under half, is internal costs within the MoD, not costs payable to contractors.

Q178 Mr. Gerry Steinberg (City of Durham): Where does that money come from, reserves or do you have to get extra from the Treasury?

Sir Kevin Tebbit: This is money that will be paid over lives of programmes. This is not this year's costs, or even next year's costs, it is a stream of costs across a long-ish period. Each year we re-base our programmes. We look at all of the programme population, Rob Fulton does this, to work out what needs to be accelerated or slowed down in order to accommodate the profile. The key thing is not the total cost in the short run but how the profile looks on an annual basis. My job as the Accounting Officer is to make sure that we come in within the budget each year.

Q179 Mr. Gerry Steinberg (City of Durham): So if that is the case then presumably if you are overrunning on something else you have to cut back somewhere?

Sir Kevin Tebbit: In-year, yes. It is a very complicated process because there are an awful lot of programmes running, some moving faster, some moving slower.

Q180 Mr. Gerry Steinberg (City of Durham): There must come a reckoning day.

Sir Kevin Tebbit: Yes. Looking at this year, for example, very specifically we brought on Storm Shadow rapidly in order to use it operationally in Iraq. We deliberately slowed Brimstone in order to make room for that. It comes through as costing £120 million-odd in the programme but that is resource costs, not costs paid to the contractor.

Q181 Mr. Gerry Steinberg (City of Durham): I am not sure whether this question is either relevant or answerable but what I am trying to do is to find out exactly what the overrun cost of defence is.

Sir Kevin Tebbit: It does not work out like that.

Q182 Mr. Gerry Steinberg (City of Durham): How much is Iraq costing?

Sir Kevin Tebbit: It does not work out like that. Let me agree with you to this extent: we cannot go on having in-year costs of 6.1% on the programme. It does not affect this year because these are costs that are spread out across a whole range of years, but we have to get it better. It was much higher than this five years ago, we have come down from about 9% annually, last year it was minus 0.4%* which was very good news, this year it has gone up to 6.1%, we have to get better and we are determined to do so. On Wednesday you will be hearing, I hope, about the various initiatives and changes that we have brought into effect in order to get a better grip on this programme. I am confident that we will be doing that but it is something that has to be done.

*Note by witness: In MPR2002 the total forecast costs of £45.4 billion were £0.2 billion below approval.