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UK Auditors See Struggle to Contain Defense Costs

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This article first appeared in Aviation Week & Space Technology.

Auditors examining the U.K.'s defense equipment procurement plans for 2012-22 say the Defense Ministry is likely to struggle to control its costs over the next decade.

London solidified its defense spending plans last month, publishing—for the first time—a Defense Equipment Plan detailing almost £160 billion ($250 billion) worth of new ships, aircraft and vehicles over the next decade. The publication comes eight months after the release of Planning Round 12 in which the ministry announced it had filled what was then thought to be a £38 billion gap in its finances.

Officials say the report puts the Defense Ministry in a "strong position" to deliver on its plans, noting the creation of £4.8 billion contingency provision within the budget aimed at protecting against program cost overruns. Furthermore, a £8 billion of unallocated "risk funding"will allow the department to fund new programs that are urgently needed by the armed forces, according to officials. A regularly updated "Capability Priority List" will define what those needs are, depending on threats and emerging technologies.

But, while welcoming the report, the U.K. National Audit Office (NAO) has highlighted a series of concerns with the plan. When the coalition government took power in 2010, ministers reported a £38 billion gap in defense finances, dubbed the Defense Ministry's "black hole" by the media. The NAO found that the situation was in fact markedly worse—it has now been estimated to have been almost twice as large, at £78 billion.

While it says the Defense Ministry is examining spending on a more "prudent basis," NAO points out that it has not been able to audit the report in its entirety because it agreed with the ministry that it would not review equipment support costs. According to the NAO, those represent just over half the equipment plan's value: £86 billion over 10 years. But the NAO hopes the Defense Ministry's 2013 equipment report will allow it to report on this critical area.

The NAO also says that while the addition of the £4.8 billion contingency provision is a "positive step," it points out that it is less than historical trends of cost growth seen in the past. Just a 0.5% increase in inflation in 2012-22 would increase costs £3.7 billion. The report says "the department's approach to risk is still over-optimistic with no portfolio analysis. The costings are not sufficiently robust to support the affordability assertion."

The NAO's concern is that if the £4.8 billion is not enough to cover program cost overruns, the Defense Ministry may be forced to dive into the £8 billion unallocated budget, which auditors say is "essential" to deliver the Future Force 2020 plans. Using the unallocated fund to protect the core program would "result in capability gaps," they say.

Some observers note that bringing Urgent Operational Requirements (UOR) purchased for the conflict in Afghanistan into the core budget could use up of most of this fund.

At the moment, such purchases are paid for through the government's Treasury Special Reserve, which also funds military operations. General Atomics MQ-9 Reaper UAVs and fleets of specialist vehicles designed to cope with improvised explosive devices have been funded by the UOR system. If commanders want to fold such assets into the core budget, then the special reserve must be compensated.

The £8 billion "risk funding" provides little scope for new opportunities for manufacturers in the next decade. Some companies see the U.K. as reluctant to spend except for UORs. Most Western European countries publish budgets for 3-5 years, giving contractors some hope that new threats and technologies will ensure priorities emerge faster.

In addition to the NAO's skepticism, the U.K. House of Commons Committee—whose members are from all three political parties—has published a report urging the Defense Ministry to learn more quickly from errors. It also says the government should readily establish a defense industrial strategy to help improve U.K. exports, which the committee says are at a disadvantage.

As an example of ministry error, the committee points to the about-face on the Joint Strike Fighter variant choice. In 2010, on the ministry's advice, the coalition government selected the conventional-takeoff-and-landing F-35C, but in May 2012 the ministry reversed course in favor of the short-takeoff-and-vertical-landing F-35B, costing £100 million.

"It is clear that the decision was rushed and based upon incomplete and inaccurate policy development. It was taken without the ministry understanding how the change could be implemented," says the committee. "Perhaps the primary example of how little the ministry understood about this decision is the fact that it was supposed to improve interoperability. This turned out to be incorrect."

The committee says a critical part of the failure to improve defense procurement is the "absence of a defense industrial strategy, which supports appropriate national sovereignty, [and] puts the U.K. at a disadvantage against competitor countries." It calls for an acquisition strategy that prepares the armed forces to act on a national basis but with "an understanding of where a level of mutual interdependence or partnership is acceptable." The committee adds that the "length of time taken by some acquisition projects means that it may be many years before success or failure is visible, and by that time irreparable damage may have been done."

The NAO says that while the Defense Ministry is facing a crucial test, if it can deliver the equipment it needs over the next decade and establish a track record over time, "the department will be able to demonstrate it has really turned a corner."

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