House of Commons - Defence

Select Committee on Defence Fifth Report

SECURITY OF SUPPLY AND THE FUTURE OF ROYAL ORDNANCE FACTORY BISHOPTON

A Strategy for Ammunition Supply

THE INTERNATIONAL AMMUNITION AND PROPELLANT MARKET

14. Royal Ordnance have provided ammunition for British forces for over 400 years.[53] In 1987 the company was taken out of public ownership and sold to British Aerospace,[54] one of this country's most profitable defence companies.[55] We explored with the trade unions and British Aerospace the reasons why a well-established company like Royal Ordnance could not win the modular charge system contract, and whether this was symptomatic of a wider difficulty for the company in winning contracts against domestic and international competition.

15. Demand for ammunition has fallen dramatically in many countries in recent years, and in particular since the end of the Cold War. Royal Ordnance, for example, told us that demand for their ammunition had fallen by 80% since 1987[56] and when we were in Bonn recently[57] we heard from a German munitions producer how the German government's annual ammunition expenditure had fallen by three-quarters since 1990. The MoD had been spending around £300 million a year with Royal Ordnance in the 1980s, but only £80 million last year.[58] Royal Ordnance have reacted to this declining market by rationalising their factories and reducing their workforce. Since 1987 their workforce has fallen from 16,000 to 4,000.[59] In the immediate aftermath of its sale to British Aerospace in 1987, the MoD let a five year contract with Royal Ordnance for the supply of explosives and propellants which was intended to provide a cushion against these difficult market conditions while the company became more competitive. The MoD agreed to buy 80% of its requirements from Royal Ordnance at gradually reducing real prices, and at the start of that first contract Royal Ordnance's prices were in aggregate £20 million a year above world levels.[60] Royal Ordnance no longer receive MoD contracts preferentially, and there is still excess world capacity in this market. Once the MoD opened up competition for its ammunition contracts to foreign suppliers, this surplus capacity has no doubt helped it to secure lower ammunition prices.[61]

16. However, a major difficulty for Royal Ordnance in competing against foreign suppliers is that most of those suppliers have continued to be protected by their respective governments. Principally, this protection has taken the form of operating closed domestic markets. British Aerospace told us that, other than in the UK, open competitions for ammunition were only undertaken in countries without a significant indigenous industry of their own.[62] In the US and many European countries, outside bids were simply not sought.[63] The UK, on the other hand, has for several years obtained ammunition products from overseas—from the US, France, Germany, Italy, the Netherlands, Norway, Spain, Belgium, Israel, Canada and South Africa.[64] However, the MoD does not see such a clear-cut picture of national preference. We were told, for example, that Germany was prepared to buy ammunition from other countries.[65]

17. Additionally, other countries have supported the research and development costs of their ammunition producers, many of which are state-owned enterprises. Ministers told us that in the MCS case they had checked, and had received assurances from the South African government that it had given no subsidies to Denel or Somchem.[66] This rather sweeping assertion seems somewhat to miss the point, either deliberately or otherwise. It is not direct, identifiable individual product support subsidies about which UK manufacturers are mainly complaining—it is the web of hidden subsidies about which they feel aggrieved and by which they feel disadvantaged. For example, governments' support has meant that ammunition produced for export is often priced without the need to recover fully the publicly-funded R&D costs already sunk into meeting domestic orders. The situation is very different for Royal Ordnance. They told us that MoD-funded research placed with the company had reduced from £1.4 million in 1985 to £0.1 million in 1995. The company had invested £10 million of their own funds over the last 10 years.[67] The MoD estimate that currently the Defence Evaluation and Research Agency (DERA) has the equivalent of 7.5 people working on propellant research, much of it in collaboration with Royal Ordnance, compared with 10-12 people ten years ago.[68] However, the MoD cautioned that these figures might be misleading because when Royal Ordnance was sold to British Aerospace 12 years ago, the MoD's research effort and funding were transferred to Royal Ordnance.[69]

18. We heard complaints, nevertheless, that Royal Ordnance had not had full access to the technological expertise of DERA when preparing its MCS bid[70] because, as their witnesses put it, the MoD required the Agency to act as its 'customer adviser'.[71] However, the Secretary of State told us that "it is our understanding that Royal Ordnance did retain a separate DERA team for technical assistance during the MCS competitions with procedures that had been agreed".[72] Indeed, we have been briefed on two programmes over recent months—for the Stormshadow missile[73] and the Airborne Stand-off Radar—in which DERA had lent its expertise to private companies preparing bids.[74] Royal Ordnance told us that improved access to research had been one of its preconditions for keeping Bishopton open. More generally, apart from the MCS workshare and 120mm contracts, it had also sought a more satisfactory and long term relationship with DERA if it was to remain internationally competitive.[75] The witnesses from BAe/Royal Ordnance told us that although they made this set of requirements clear to the MoD, the Department had had difficulty lifting its view above the individual contracts being considered and on to these wider trade-offs.[76] The Secretary of State saw the events rather differently. He told us—

19. Whether through the failure of the MoD to anticipate problems in sourcing its ammunition supplies in the UK or through failures on the company's part, Royal Ordnance has simply not been able to develop and maintain the research base necessary for bringing a world-beating modular charge system to the market. The MoD appears to want to allow propellant research by Royal Ordnance and other ammunition suppliers to be left to commercial considerations, while also continuing to run its own research programme (some of which provides it with an 'intelligent customer' capability). The evidence we have heard leads us to question whether the MoD's approach is working to the benefit of the UK. In this sector of the market, it would appear that DERA has had difficulty reconciling its objective of supporting UK defence industry capabilities with its requirement to operate under the commercial imperatives of a trading fund agency. This case raises important issues with relevance across many defence technologies, which the Committee has decided to examine in a wider inquiry into defence research expenditure. In that inquiry we intend to examine the basis upon which defence research is undertaken, the question of strategic research capabilities, and the implications of the proposed public-private partnership in DERA.

20. Another factor behind Royal Ordnance's difficult market position appears to be the generally lower cost base in some other countries, including South Africa. Lord Gilbert told us that "there is no question at all that South Africa has an advantage over this country insofar as its wage costs are very low and ... propellant manufacturing is a fairly labour intensive industry".[78] As a result Royal Ordnance had not always been able to offer the best price in competitions.[79]

21. The MoD's arms' length approach to competitive tendering in recent years has helped to keep its costs down. As a result, Royal Ordnance have clearly been at a significant disadvantage in competing with foreign ammunition manufacturers, and have had to operate without the same degree of government assistance and support enjoyed by their competitors overseas. In addition, the lower cost base of manufacturers in countries like South Africa is likely increasingly to challenge the firm's competitiveness. At the same time, it appears to us that Royal Ordnance may well have compounded its problems by a failure adequately to invest in and to modernise Royal Ordnance's manufacturing plant and intellectual property. If this is so, it is particularly disappointing in view of the easy terms on which British Aerospace acquired Royal Ordnance, and the latter's guaranteed MoD work following the sale.

FACING UP TO THE CHALLENGE

22. We have seen that Somchem's bid was the clear winner for the modular charge system contract, on both price and technical grounds. It would also appear that the most plausible scheme for keeping Bishopton open for just the next few years would cost the MoD some £20 million (paragraph 12). In the current trading environment, and with the UK apparently fated to play uphill on the distinctly sloping playing-field outlined above, perhaps our greatest fear is that Bishopton may not be the only Royal Ordnance plant with a doubtful future. British Aerospace told us that they saw an urgent need to resolve the future of Royal Ordnance, particularly its structure, shape and capabilities, but that any proposals would have to balance British Aerospace's responsibilities to its workforce, customers and shareholders.[80] If it was decided that maintaining a national capability was strategically important for the UK, they argued that the cost would have to be met by the MoD rather than British Aerospace—or, as the company euphemistically put it, as a commercial enterprise it "would need to ensure that the assets which it would deploy were in accordance with shareholder principles".[81] Closing sites like Bishopton would bring disposal receipts for the company, but also clean-up costs ahead of any redevelopment. The witnesses from British Aerospace were somewhat reluctant to be open about these costs and vague about both figures,[82] but insisted that such one-off factors, which might be expected to improve short-term cash-flow, would not be taken into consideration in their longer term decision-making.[83] Indeed it is not evident that disposal of propellant manufacturing sites would even yield a net surplus. By way of comparison, MoD drew our attention to the costs of cleaning up Ravenscraig steel works, on the basis of which it estimated that the clean up costs for Bishopton might be in the region of £25-£30 million.[84] However, the most obvious factor driving Royal Ordnance's decision to close the factory is their inability to contrive a plausible commercial future for the plant.

23. The trade unions argued the case for a long term MoD strategy for ammunition supply, which could at least make investment more economically viable. British Aerospace has invested £34 million in Bishopton since 1987, including £20 million on upgrading the infrastructure.[85] Mr Dromey of the Transport and General Workers Union told us that—

24. We have no doubt that it is difficult for a private sector firm to make major strategic decisions, and back them with shareholders' cash, when the MoD has not given a clear indication of its longer term intentions for ammunition contracts. A succession of short term contracts has not been conducive to the long term stability that investment decisions require. But Royal Ordnance's failure to win the modular charge system contract, and indeed our own keen interest, does at least appear to have acted as a catalyst[87] and has brought them together with the MoD to discuss the potential for replacing short-term fixed term contracts[88] with the kind of longer term 'partnership' arrangements envisaged under the MoD's 'smart procurement' initiative (smart procurement, which we reviewed in our recent report on the Strategic Defence Review,[89] involves a more integrated relationship between the MoD and its suppliers in managing equipment programmes to provide better products more quickly and more cheaply). The hope is that such an arrangement might provide a viable future for what is still a highly capable Royal Ordnance, as the Secretary of State recognised—

Without these arrangements, however, Mr Dromey considered that we may end up with only three out of the ten Royal Ordnance factories surviving.[91] While some rationalisation may well be needed, this must be the product of a long term strategy based on a clear new 'partnership'. It is the possibility of the unplanned effect of the closure of Bishopton on the rest of Royal Ordnance's operations that gives us particular concern.

25. Since our hearings in February and March, the MoD and British Aerospace have held a series of discussions about such a possible long term partnership, which might give Royal Ordnance greater confidence about the MoD's work programme. When they appeared before us over two months ago, British Aerospace were then very reluctant to give us details of these discussions while they were underway,[92] pointing out that above all a resolution requires a considerable input from the MoD as their customer.[93] This is only half the story, however, and British Aerospace must grasp the nettle of their own long term strategy for Royal Ordnance. We understand that such a partnership, with commitment shown by both the Department and the company, would make it easier for other munitions firms to merge with Royal Ordnance or form joint ventures.[94] We would not expect any new partnership arrangement to guarantee work for Royal Ordnance, no matter what the cost—indeed, the payback for the MoD must be the prospect of more competitive prices. We had hoped that these discussions would have provided an opportunity for retaining a role for Bishopton. The Secretary of State told us, however, that having examined the data, he had been forced to conclude that Royal Ordnance have wanted to close Bishopton,[95] and British Aerospace have now told us that after their discussions with the MoD they have confirmed their plans to close the site.[96]

26. We welcome the news that partnership talks between the MoD and British Aerospace are now underway. It is regrettable that discussions about a partnership relationship for ammunition and propellants began so late, and had to be prompted by the crisis over Bishopton's future. The MoD and British Aerospace both have important roles to play, and we are concerned by the evidence of this inquiry that each has shown some reluctance in committing itself fully to the enterprise. Although the MoD's approach to contracting for ammunition supplies inevitably influences the company's long term competitiveness, the Secretary of State told us that plans for Bishopton and its other facilities were a matter for Royal Ordnance and its parent company.[97] British Aerospace too must rise to the challenge, and be prepared to give Royal Ordnance the infrastructure and long term research base it needs to be competitive in the international market.

27. We note, however, that a critical component of smart procurement remains the need for contracts to be based on the disciplines of competition, albeit a competition undertaken early in the procurement process to set the framework for the subsequent partnership. It remains to be seen whether any improvements in economy and effectiveness that might be possible from partnerships and other smart procurement techniques will be sufficient to allow Royal Ordnance to compete on price and quality with firms like Somchem. Unless they are, the question of whether the MoD is willing to pay a premium to retain UK capabilities for ammunition and propellants will remain. That decision in turn hinges on whether such capabilities are sufficiently important in strategic terms for the UK.

STRATEGIC CAPABILITIES

28. In our inquiry last year on aspects of defence procurement and industrial policy, undertaken jointly with the Trade and Industry Select Committee,[98] the MoD told us that they had—

... addressed the extent to which key defence industrial capabilities should be sought to be retained. The criteria against which the desirability of retaining defence industrial capability can be assessed are defence-based, rather than encompassing wider industrial or economic objectives. They are intended to ensure that the UK retains a capability to:

meet operational requirements, unique national commitments, and maintain indigenous technologies;

support existing and future systems, secure industry support for military operations, and to regenerate critical equipment;

contribute, from within a restructured European industry, to collaboration;

avoid the creation of a monopoly or over-dependency by a company or country;

promote defence exports.

29. The Minister for Defence Procurement also reminded us of his comments during that inquiry[100] that from a military perspective a list of items whose procurement in the UK was absolutely critical would be very short, and that many types of future conflict would not allow time to replenish central ammunition stocks until hostilities were over.[101] In his evidence to this current inquiry, he pointed out once again that "we now live in an interdependent world".[102] The Chief of Defence Procurement told us that Germany were currently negotiating mutual dependency arrangements for ammunition supplies with another European country—a consequence in part of reducing demand and increasingly accurate munitions.[103] The Secretary of State pointed out that while Europe spends two-thirds as much as the US on defence it fields a capability of only 10% as much, in part because of unnecessary duplication in defence industry capabilities and overcapacity. "If we are going to have a much greater European defence capability" he told us, "perhaps we are going to have to address some of these issues."[104]

30. However, if dependence—mutual or otherwise—means that we cannot be absolutely confident of the availability of supplies from outside the UK, the question of what constitutes a 'strategic capability' assumes more importance and becomes more complex. In some quarters, 'strategic capabilities' are considered to be those which must remain located in the UK, both physically and intellectually, and must remain susceptible to direction by the UK government in times of crisis. To determine whether a technological or industrial capability ought to be preserved in the UK is a complex matter, involving weighing in the balance both operational and financial considerations, as well as short term and longer term perspectives. If we were to conclude that we cannot depend on allies to provide supplies when there is a competitive market, then self-sufficiency could prove very expensive. Even the US does not follow such a line. As the Minister for Defence Procurement pointed out—

105

And when asked if the MoD had taken a view on whether propellants were a strategically essential manufacturing capability, the Secretary of State replied—

106

31. There is also a broader interpretation of 'strategic capability' which is focussed on ensuring that critical supplies will be available when required, whether or not the manufacturing capability resides in the UK. Few would argue against the proposition that ammunition falls under this definition of a strategic capability. In peacetime, it remains important that training and minor operations are not disrupted because the supply chain—whether from overseas firms or within the UK—cannot meet the forces' requirements when needed. In theory, in times of crisis the supply chain from industry ought to assume less importance, because war stocks should already be in place to support operations, and the opportunities for resupply from industry—even from UK industry—would have limited scope to influence matters before the resolution of the crisis. The experience of Kosovo, however, may force us to re-examine this assumption. Even if it stands up, two key questions remain. These are: whether for operations there are sufficient stocks already held (the question of war stocks); and whether for peacetime needs there are sufficient competitively-priced sources of ammunition and propellant which can be relied upon to meet training needs and for making good war stocks run down on operations (the question of security of supply). We now go on to examine these issues.

53 The Royal Powder Mill was established in 1560 Back

54 Royal Ordnance, previously publicly-owned, was put onto a corporate footing in 1985 and sold to BAe in 1987 for £190m Back

55 BAe's preliminary figures for 1998 show a pre-tax profit of £973 million Back

56 Q 264 Back

57 3-4 March 1999 Back

58 Q 382 Back

59 Q 211 Back

60 'Military of Defence: Sale of Royal Ordnance plc', Report of the Comptroller and Auditor General, 1987-88, HC 162 Back

61 Q 361 Back

62 QQ 305-6 Back

63 QQ 304, 306 Back

64 HC Deb, 29 March 1999, c485w Back