CEDA hompage  »  research  »  Past research  »  Defence and defence industries  »  The Business of Defence: papers from Growth 57

The Business of Defence: papers from Growth 57

CEDA's Growth report The Business of Defence - Sustaining Capability finds that more transparency in relationships between the Australian Defence Force and the businesses that supply it will produce better strategic and economic outcomes. You can see more about the Business of Defence report.

This collection of papers argues Australia's defence industry strategy is at a turning point. However much they may otherwise differ, this view is shared by all contributors to this study. There are three primary reasons.

The first results from the globalisation of the industry structure. Much future procurement will involve Australian firms as sub-contractors to the global supply chains of major offshore primes. This new pattern of relationships poses a host of collaborative, technical and distance challenges for Australian firms.

The second reason to develop a new approach arises from the unique character of the defence industry. Government is the sole buyer. In the interests of national sovereignty it needs to preserve local capabilities at least sufficient to sustain through life support and repair in times of war. But this is no easy task. Subcontract relationships to off-shore primes reduce its degrees of freedom in developing an industry structure to its own taste. Further, technological and other uncertainties remain large and can evolve significantly through the life of a project. At the least, these latter considerations increase the pressure on government to be clear about what it wants. It also invites government to play a more active role in the development of collaborative capabilities at the firm level and to develop new forms of linkage with its industry partners.

Third, uncertainty surrounds Australia's geo-political outlook, yet procurements involve long term decisions. The key issue here concerns the extent to which Australian forces will operate in conjunction with those of major allies or semi-independently in more localised conflicts.

While there are differences of emphasis and perspective between the papers, there is general agreement that the response requires more investment in the conception or strategic phase of projects, closer links between the services and industry specialists in the development of equipment requirements, and more transparency. In addition, alliance contracting and other novel approaches are likely to become more prominent in the relationship between government and its suppliers in delivery phases. These are a response to technological and other uncertainties, such as bidding for work with international primes. But these organisational developments need to be associated with acceptance of a more directly catalytic role by government and more transparency in relationships.

The UK Defence White Paper: A model for Australia

In general, for its clarity about challenges, about the capabilities required to sustain national sovereignty and for its detailed attention to organisational and institutional issues, the United Kingdom's recently produced Defence White Paper presents a model for what is required, in another key, for Australia.

Aligning defence and industry strategy

Paul Dibb introduces the collection with a call for a much closer alignment between defence strategy and defence industry. He proposes a defence industry policy that identifies those local industrial capabilities that are important for defence self-reliance and supporting independent ADF military operations. He cites the recent UK White paper as a model for Australia. Dibb reviews the history of past failed efforts to better link defence policy and industry. The most recent attempt tried to identify industry capabilities that are essential to achieving through life support, combat repair capabilities, and desired levels of national sovereignty. This was to avoid the boom and bust environment associated with project by project acquisitions. This policy was designed to vary the relationship between suppliers and purchasers towards one in which the sustainability of key industry capabilities would be the primary consideration. Open competition would occur primarily in this context. Despite repeated statements of intent, the Australian defence establishment has mostly failed to realise this outcome. The only notable exception is the Defence Electronic Systems Sector Plan, which sets out-for the first time-clear priorities.  Further, publication of the Defence Capability Plan 2001-2010 was intended to be associated with a more open climate of information exchange. This was realised in the 2002 update and again in 2004 when comprehensive Plan revisions were published. But thereafter 'Defence's enthusiasm for publishing such detailed information seems to have gone'. This is despite the fact that there have been significant changes in planned defence procurements. Dibb concludes that Defence does not accept that its dominant purchasing power can and should shape the industry. This is by contrast with the UK approach where this framing is whole heartedly embraced. Dibb proposes an analogous approach for Australia (recognizing differences in scale and diversity of industry) and concludes with a detailed discussion of the required steps.

Procurement and recruitment

In the second paper, former Defence Chief Chris Barrie discusses the environment surrounding defence procurement and recommends steps to strengthen present arrangements. Noting the impact of population aging, he repeats his call for wider discussion of a new scheme of national service. Given the shrinking of the relevant age cohort, an all-volunteer military is, in Barry's view, hardly likely to be tenable. But a viable military force is essential for Australia's security. To gain public recognition of the stakes, the issue must be publicly identified and there must be debate about how adequate numbers can be sustained. Turning to procurement, he notes that Defence created a new National Support Division in 1997 to strengthen its links with industry. He discusses the various factors which should shape this relationship. So far as investment in industry is concerned, he endorses Dibb's call for a fresh approach based on the identification of essential industry capabilities. He also notes the savings that have accrued from a much more extensive use of private sector contracting. The scope for reducing waste nevertheless continues. Further, with improved cooperation between suppliers and the department, it should be possible to reduce the lead times for major items of capital equipment from the present 10-15 years to 8 years. But to accomplish this, the current stop-start procurement model needs to be replaced by a closer, alliance relationship between Defence and its suppliers. This is reinforced by developments in technology. Barrie also discusses the size of national stockpiles and, as noted at the outset, emerging problems concerning the recruitment and retention of skilled personnel not only in the Services, but also in industry. He recommends a complete separation between DMO and the Department and concludes, like Dibb, with a call for a new statement of government policy along the lines of the British White paper. 

Innovation

Richard Brabin-Smith turns to the priorities for defence innovation in Australia. There are four broad circumstances where Australia needs to develop its indigenous defence research and development program. Firstly, Australia's special maritime and land features mean critical needs may not be met by other defence equipment suppliers. Second, there may be compelling national security considerations such as technology support to counter terrorism. Thirdly, even Australia's closest allies will not share the defence information associated with high levels of security sensitivity (such as source code release). Fourth, a new idea might emerge with compelling potential benefits. Brabin-Smith also describes the role and achievements of the Defence Science and Technology Organisation (DSTO). For the future, he anticipates that Australia's specific geographic needs will drive a need for research and innovation. Further, global industry consolidation may narrow options unacceptably from the perspective of Australia's own priority needs. Joint projects led by overseas partners will presumably expand. Finally, Brabin-Smith finally calls for a cultural change in the defence industry: greater recognition of the importance of science; a greater willingness to seize opportunities for innovation; and less reluctance within the Defence establishment to embrace local innovation.

Competition

In the fourth paper, Mark Thompson reviews the history and background of the role of competition in Australian defence procurement. Strategic requirements are usually expressed as the in-country capability to repair, maintain, and modify Australian Defence Force (ADF) equipment. These strategic imperatives meant that defence industry has consistently been characterised by other than a competitive environment. For example, in 1986, seeking to improve productivity, the government commercialised its defence industrial assets. This introduced a qualified form of competition that continued a long tradition of giving preference to local industry.

This was followed by the Australian Industry Involvement (AII) program in the late 1980s. The AII program sought to develop strategically important local industry capabilities and to maximise local content consistent with achieving value for money. However, in practice the AII program served economic rather than strategic imperatives. Although some through-life-support capabilities accrued for the ADF, local content was given implicit preference. Former minister Reith proposed a new "strategic approach", aiming to move away from project-by-project approach and towards longer term multi-project partnerships between defence and selected firms via "open book" alliance contracting. But appropriate sector plans have not been forthcoming. Meantime, in the shipbuilding sector, the government resorted to "managed competition" to build three Air Warfare Destroyers (AWD). Thompson concludes by recommending that the government sort out the strategic capabilities it needs to keep in-country and use open competition on the global market to equip the Australian Defence Force.

Valuing defence

Stefan Markowski and  Peter Hall also consider how the value of the defence industries might be estimated. They outline an economic framework for assessing the benefits of in-country defence industries. The "defence value-adding chain" is made up of the value and cost of defence-related capabilities; defence material (materiel?) imports and domestic industry supplies; and the interface between the Australian Defence Organisation and the upstream suppliers of goods, consumables and services in the defence industries. In theory, the value of the end product of the defence value adding process, i.e., national security provision, should determine that of intermediate outputs and capabilities of upstream suppliers. However since the true social value of national security cannot be assessed in peacetime, judgment is unavoidable.

Markowski and Hall then discuss the distinctive nature of defence industry, paying particular attention to ownership and competitive issues. To be internationally competitive, they argue for specialisation in niche products. They are critical of policy justifications such as job creation and technology transfer, which are too frequently invoked as a rationale for defence industry protection. For example, in the case of technology,  the best way to accelerate technological change in civil industry is to target the civil industry directly. But they also recognise that the valuation of the benefit of defence capabilities presents many technical and practical challenges. To the extent that it reflects judgments about the value of national defence, subjective elements are unavoidable. The judgement involves an assessment of the most efficient way of achieving security objectives, and the potential for domestic suppliers to deliver products and services. Established industry interests may seek to influence these judgments and political considerations may affect defence strategic analysis. The only counter to such pressures, is transparency in decision making and accountability throughout procurement processes. If government is to support domestic defence industries, this should be strictly based on strategic-defence considerations only.

Industry structure

Bob Wylie then provides a detailed account of the role and structure of Australia's defence related industries. He focuses on six major procurement areas to illustrate the range of activities and firms. These cover non-combat support, defence information capability, naval ships, boats and submarines, army land-based manoeuvre, defence munitions, and military aviation. In each area, he reviews current and prospective workload, the major suppliers and the links between local and international firms. He argues a robust defence industry broadens the military options open to Australian government in pursuing strategic objectives. But he also notes the new complexities in procurement, including the impact of increasingly complex and knowledge-intensive systems. Learning by doing, learning by using and learning through the interaction of users and producers are now all critical to industry success. Further, procurement of knowledge-intensive systems is shifting industry focus increasingly to services. This often requires close geographic and functional proximity between the customer and local suppliers. In a context in which Australian procurement is closely linked to international suppliers, this creates especial pressures for local firms, and a rationale for the continued support of local industry.

Case study 1: The Joint Strike Fighter

Two case studies of procurement follow. Christopher Wright examines the impact of the JSF program on the Australian defence industry. He reviews the prospects for the sector should the procurement approach adopted for JSF be applied broadly across future defence acquisitions.  The JSF involves local consortia seeking to qualify for Lockheed Martin's global supply chain. Via a (nominally) competitive process, Australian companies are being considered as tier 3 suppliers. Wright suggests that, in a complex technological environment, companies that have a clear focus and that offer discrete products or services are best positioned to succeed. Moreover, in some aspects, smaller companies may find themselves in a more advantageous position for through life support. As the JSF program moves into the production phase, companies that are able to maintain their cost, schedule and quality performance and to offer complete packages competitively may be the base for sustainable industry capability in Australia. These companies are unlikely to be the larger primes that have traditionally dominated Australian defence industry.

Wright predicts that the JSF has the potential to significantly affect the worldwide defence industry. Like Thompson, he argues that Australian Industry Involvement (AII) and its forebears no longer represent a viable approach. Significant structural adjustment will follow the JSF approach. The burden of this will fall mainly on the larger primes. The decision as to what capabilities remain will be market driven, not government prescribed. The JSF approach favours a market mechanism, not government intervention, as the instrument of choice. This approach will complicate any alignment between defence strategy and industry capability. To the extent the JSF model prevails, the shape and structure of the industry will depend on the management decisions of US companies further up the value chain. The US defence industries' own traditions are an additional complicating factor. Its culture has historically strongly preferred domestic suppliers to those off-shore.

Case study 2: The Air Warfare Destroyer

In the second case study, Derek Woolner examines procurement of the Air Warfare Destroyer (AWD) project, the most complex naval surface vessel project ever attempted in Australia. He argues that the problems associated with past acquisitions mostly reflect decisions made (or not made) earlier in the life of each project, that is well before the contractual phase. The Collins submarine provided a classic example. Successful procurement requires broadly a three-step process. First, a pre-contract strategic phase when geo-political, technical and production issues can be thoroughly aired. Second, a contract phase, when issues surrounding the detailed specification and the relationship between purchaser and providers are considered. And third, a project management phase. The AWD project illustrates these latter requirements. This project is to be managed under the alliance contract model. Although this model provides incentives for the contractor to save on cost, it requires transparency both between the purchaser and contractors and between individual contractors. In addition, the AWD project is to be based around the Aegis air warfare system. In selecting Aegis, the government has avoided the risk of a new or unproven system. Woolner also applauds the choice of ASC because of its experience, the need for through life support and its strong links with a US builder.

Nevertheless, this procurement is not unproblematic. Problems might be expected from the integration of the Aegis system. Aegis requires a large displacement vessel. It also requires commensurate crew numbers. Yet for a decade, the RAN has suffered personnel recruitment and retention difficulties. Other features of this contract - such as significant ship automation and management systems, systems integration of sensors, command and weapons - have historically caused problems. These risks have been recognised in the appointment of the AWD principal's Council. Woolner concludes that more is needed. Alliance contracting requires a new type of supervisory agency. This would allow a focus on the whole program to be maintained, and it would allow alliance arrangements to be altered if necessary.

Defence politics

In a final paper, Geoffrey Barker looks at the interplay of economics and politics in major procurement decisions. Hefirst reviews the structure of Australia's defence industry and its special relationship to the Federal Government. While the profitability of defence industry is broadly in line with that of the general manufacturing and services industries, the industry overall is not particularly robust in terms of its ability to meet future defence needs. The monopsony position of the Government requires a fine balance between efficiency and the political interest in a sustainable and healthy industry. Barker agrees with the government's view that a profitable and capable defence industry is imperative for Australia's self-reliance, but he wonders if current strategic policies, such as the government's Defence Capability Plan, will achieve this. Defence's four current sector plans (aerospace, electronics, shipbuilding and land) are inadequate.

Barker then reviews acquisition arrangements since the 2003 Kinnaird Review and the establishment of the Defence Material Organization (DMO) as a semi-independent executive agency within the Defence Department. He believes that the Kinnaird review proposed a rational, market-like and outcome-driven framework for the management of acquisition projects. Its centre piece was a "two-pass" system for defence procurement: the first stage involving the analysis of options to meet an identified capability need and the second pass being the assessment of the supplier options followed by government approval for tender and contracting. This was fine in theory - but it has been breached in practice. For example, on the JSF project, only a limited process of comparing and evaluating alternative options was undertaken. The acquisition was decisively influenced by Australia's strategic alliance with the US. The purchase of naval combat systems further illustrated the role of alliance relations, the desire for maximum interoperability and the imperative of access to fast-evolving US military technology. Economic competitiveness had to be weighed against these other factors. Barker concludes that politics is unavoidable. A competitive/comparative analysis of major procurements is the ideal, but it is an unattainable one.

A new policy framework

Together these papers provide a comprehensive overview of the circumstances that confront, and the outlook for, Australia's industry support capabilities. There is substantial agreement between them on the general factors which are shaping the defence procurement and industry environment, but there are also significant differences of emphasis and interpretation.

Three factors would seem to be primary in the development of a policy framework.

First, the government's own geo-strategic determinations will prescribe likely scenarios around which general defence capabilities need to develop. There are naturally many uncertainties here, not least the emphasis between neighbourhood, regional and alliance responsibilities.

Second, these general capabilities will be the foundation for identification of specific strategic capabilities that need to be developed in local industry to ensure through life support of equipment and repair of critical components in times of conflict. Many factors, not least technology, create an array of options here.

Third, the capacity of local suppliers to successfully enter the supply chains of global primes will also be an important factor in determining levels of local defence industry activity. In this latter area, government can play a facilitating role, but unlike in the past, market forces will be primary.

A new policy framework needs to reconcile and balance considerations such as these - considerations which are both not readily consistent and also substantively problematic.