House of Commons - Defence

Select Committee on Defence Ninth Report

THE FUTURE OF DERA

MAKING DERA A MORE COMMERCIALLY RESPONSIVE ORGANISATION

71. When the DRA was originally established as an agency in 1991 it was intended to provide a more efficient research organisation within the MoD. The trading fund status conferred on it in 1993 (and inherited by DERA on its establishment in 1995) was to make it a more commercially minded, responsive and cost effective body. The 1993 White Paper Realising Our Potential anticipated that the agency would establish—

156

72. As a trading fund, DERA is already able to use its income to support expansion of its business (and to expand business in anticipation of the income it would receive, provided such revenues were a near-term prospect). DERA can borrow to cover its working capital needs (such as stocks and debtor-balances) and its capital expenditures, but only with the approval of the Secretary of State and subject to laid down limits on overall temporary borrowing and external finance.[157] It is required to generate revenues to at least match its running costs, and is required to charge its customers the full cost of its services. The MoD seek in a privatised DERA the opportunity for creating a yet more commercially driven organisation. A private sector business, however, could choose (or might be forced by market conditions) to undertake just those activities that present opportunities for profit, or to charge market rates for its services rather than seek simply to cover full costs. A privatised DERA might have the incentives of a private sector organisation to seek business and deliver against contracts on time, while controlling costs closely, but to a large extent DERA already has these incentives through the quasi-contractual relationship it has with the MoD and has successfully responded to them. The MoD told us last year that—

158

Indeed, Sir John Chisholm told us of his view that while changes were necessary, in many respects DERA would retain the same core values—

de jure

de facto

159

The compliance regime ... may sound onerous, but that is the world we live in at the moment. I personally have been involved in the inventing of the current regime. I know it works. It may sound onerous but it is all to do with how we shape our organisation and it is in our blood to operate in that way, and I believe therefore it is an entirely workable regime.[160]

We find no evidence to suggest that DERA is underperforming under its present structure and public ownership. The MoD has not made a convincing case that the incentives which might be introduced with privatisation would be likely to bring benefits which would outweigh the risks.

73. The consultation document also highlighted two specific areas where the MoD believed that changes could be made under a public-private partnership to make DERA more responsive to the challenging operating environment it faces—easier access to capital and more flexible remuneration for DERA staff.

IMPROVING DERA'S CAPITAL STOCK

74. DERA does not get any funding other than from its own resources, paying for its capital programmes off its own balance sheet.[161] Its borrowing is however controlled, because it counts against the public sector borrowing requirement. DERA's funds have been used over the years to provide and maintain an infrastructure essential for it's research and evaluation work— ranges, test facilities, wind tunnels and so on.

75. There have been two waves of rationalisations of such facilities: the first followed the establishment of the Defence Research Agency in 1991, which drew together four previously separate research bodies,[162] and the second came after DERA was established in 1995 as it subsumed further research establishments.[163] These rationalisations, however, have not been able to keep pace with the steadily falling external demand for DERA's test and range facilities, and increased efficiency in their management has only served to reduce the time that they are in use even further. In 1996-97 test and evaluation facilities were only 60% utilised,[164] and demand was projected to fall further by nearly a fifth over the subsequent five years to 2002 because of less demand for physical testing of new systems (a result of greater use of computer simulation and modelling), competition from other testing suppliers and the MoD's increased emphasis on equipment suppliers themselves determining test and evaluation requirements.[165]

76. The Society of British Aerospace Companies (SBAC), whose members often used such facilities, also saw some scope for further rationalisation of research facilities, particularly if the money saved could be diverted to research work—

166

77. DERA has recently placed its Pendine and Shoeburyness land ranges on a stand-by footing and concentrated work on its Eskmeals range, saving £7 million a year,[167] and it is currently re-examining its whole test and evaluation business. It plans to revamp it, though it will be on a smaller scale than before. This will involve taking some of the wind-tunnel facilities at Bedford and Farnborough out of commission,[168] but greater investment on some trials and test infrastructure, including the Triton trimaran demonstrator, new trials aircraft and a computer network linking physical trials to laboratory-based synthetic environments.[169]

78. Like DERA's test and evaluation facilities, its accommodation and laboratory facilities have also been reduced. This has gone alongside a marked improvement in the quality of laboratory accommodation (which we have seen ourselves during visits to Farnborough). The opening of the new Farnborough headquarters in 1998 completed a rationalisation programme that saw the closure of 15 smaller sites.[170] The result is that currently half of the organisation is accommodated in modern, purpose-built laboratories.[171] While the capital investment needed over the last seven or eight years had been met from DERA's cash-flow, Sir John Chisholm told us that this was getting more difficult. Although approximately half of the agency were in relatively modern laboratories, dealing with the rest would absorb the remaining flexibility he had over capital resources. Capital would be needed to update the facilities for areas of DERA's businesses where demand will grow in the future.[172] In particular, facilities for certain new technologies—electronics, IT and communications—need further investment. DERA's Site Strategic Plan[173] postulates three possible ways forward for the next five years—

a 'Base Case' scenario, involving a minimum investment in the estate;

a 'Core Site Development' scenario, involving improvements and refurbishment at five sites, requiring a small increase in running costs; and

a 'phase 2 rationalisation' in which running costs would be cut from £116 million a year to less than £100 million by 'bringing the great majority of the DERA estate up to a modern standard' at four principal laboratory clusters—Farnborough; Boscombe Down/Porton Down; Portsdown West and satellite sites; and Malvern. This would leave the future of Fort Halsted, Bedford, Winfrith, Rosyth and Bincleaves (which between them employ a fifth of DERA's workforce [174]) in some doubt, and indeed it does appear from recent press reports that a decision to close Fort Halsted now appears closer, with speculation that its explosive/propulsion research operations could be transferred to the Atomic Weapons Establishment.[175]

79. Borrowing from the financial markets to fund such schemes will be more expensive for a privatised DERA than the relatively low cost of government borrowing (as a trading fund, DERA currently bears in its commercial-style accounts a notional cost — 6 per cent — of holding capital). The extra cost of finance might be partially eased if the government were to issue guarantees to the creditors of a private-sector DERA, but a simpler and less risky approach would be to retain the Agency's trading fund status and raise its borrowing limits. Although such borrowing (counted against Public Sector Net Borrowing[176]) would not breach the Treasury's 'golden rule' which permits borrowing for capital investment, it would we suspect offend against the Treasury's perceived determination to constrain government borrowing more generally.

80. The MoD told us that a privatised DERA would be required to consult the Department on any proposal to dispose of key facilities, to ensure that they did not present a risk to national security or result in a loss of critical capability. The MoD is considering possible clawback options for it to share in the proceeds from such disposals.[177] The requirement under a public-private partnership for the MoD to be consulted before DERA could dispose of its facilities is an essential safeguard. Some facilities, though not fully utilised, remain essential national assets. They play an important part in allowing the UK to develop world-leading technologies, and make it possible to upgrade fighting equipment already in-service at sometimes very short notice. The MoD must be able therefore to insist that DERA retain such assets, or at least to have first refusal to bring them back into MoD ownership. To retain such safeguards would, however, negate much of the purpose of privatisation—the unshackling of the Agency's management from the supposed constraints of the public sector.

IMPROVING DERA'S HUMAN RESOURCES

81. DERA directly employs nearly 11,600 staff.[178] Including contract staff and military personnel attached to DERA, the total exceeds 13,000.[179] DERA's scientists and engineers have a high reputation, both nationally and worldwide. The trade unions have highlighted concerns, however, about some aspects concerning the staffing of DERA, including relatively modest salaries in DERA compared with the private sector (the average salary of DERA staff is some £24,000,[180] though a broad average is not very illuminating) and the prevalence of fixed-term (rather than 'permanent') contracts as factors putting off would-be new recruits and encouraging high staff turnover.[181]

82. The proportion of DERA's directly employed staff in the professional and technical grades—those most closely associated with its research work—has now risen to three-quarters[182] (Figure 10). While overall 7% of those science and engineering staff are not on permanent contacts,[183] the figure is higher for newly-recruited staff.[184] Staff turnover in DERA was 10% in 1998-99, with 1,168 of the 11,593 staff leaving in that year,[185] up from 8% the previous year.[186] Part of the wastage has come from cut backs in some areas of activity which are in less demand: 300 posts were cut in 1998-99 in the mechanical sciences and land range areas, resulting in 174 staff being made redundant or retiring early. In other areas, however, DERA has had difficulty recruiting as many graduates as it wished,[187] and specialists in the new technologies. Sir John Chisholm told us that there were areas of DERA's business which had been 'black holes' in its technology coverage. Though they had in the last few years managed to fill vacancies in some of these areas, in others—such as communications technologies, software, and biotechnology—it was still hard to keep up.[188]

The proportion of staff in professional and technical grades has risen from 44% in 1991-92 (when it was the Defence Research Agency) to 75% in 1998-99 (when DERA).

Source: HC 411, page 29; and DERA Annual Accounts 1997-98 and 1998-99

83. Although tied to the civil service remuneration system, DERA has been able to employ some flexibility in the pay and conditions of its staff. In 1995 it reformed its pay and grading system to provide greater incentives for rewarding individuals, and the reformed structure does not have rigid grades to which particular jobs are tied.[189] DERA staff may be able to benefit financially from any income derived from inventions not directly related to their main work—10% of income between £150,000 and £300,000, and a smaller percentage of more lucrative inventions.[190] DERA also encourages further professional qualifications for its staff (1,000 staff have PhDs[191]) and has introduced a DERA Fellowship scheme to show recognition for its most senior scientists and engineers.[192]

84. Despite these developments, DERA still has to operate within the overall Treasury guidelines on pay settlements in the public sector.[193] As a private sector organisation, DERA's senior directors could perhaps expect a much higher salary. DERA's 1998-99 Annual Report notes that the Chief Executive and Finance Director, for example, were paid £170,000 and £125,000 respectively last year—a level exceeded in many defence companies. The chief executive, however, sought to assure us that he was not developing the proposed public-private partnership for personal gain,[194] and drew our attention to the greater flexibility that he sought for rewarding DERA's scientific staff—

195

The trade unions were less convinced of the need for radical change—

196

DERA [also] have ... flexible entry packages to meet particular needs [with enhanced starting salaries to help recruitment in key areas in which there is strong competition from the private sector, such as IT and communications technologies[197]]. We think that process could be continued, particularly if you remove ... one of the elements of inflexibility—the need to clear pay remits and some of the detail [with] the Treasury.[198]

85. Sir John Chisholm was sanguine about the prospects for DERA's personnel retaining public sector values under the regime he envisaged—

199

Again, however, the trade unions have yet to be convinced—

200

86. One of our industry witnesses noted that "it does seem strange that we are tearing the whole [DERA] thing up, just to solve the salary problem".[201] Some additional flexibility on staffing matters would no doubt help DERA to recruit and retain the staff it needs, including those needed for the critical technologies where skills are heavily in demand. A public-private partnership however is not the only way, or the most cost-effective way, to achieve this.

IMPLEMENTING SMART PROCUREMENT

87. Smart procurement, one of the most discussed policy initiatives of the Strategic Defence Review, was the third driver for change identified by the MoD in its consultation document. It is designed to change fundamentally the way defence equipment is acquired., and involves a greater degree of partnership with industry in finding technical solutions and delivering them much more quickly and cheaply. Among other things, it involves a shift in emphasis towards the initial research and early technology demonstration work needed to put equipment projects on the right lines. General Burton, then Deputy Chief of Defence Staff (Systems), told us that—

The context for applied research and corporate research is now very much developing the thinking on smart procurement, which places a premium on early and carefully directed appliance of science and technology ... so that we trap those technological lines of development that are most likely to deliver success and operational benefit at a price that is affordable ... A fundamental [new] step is that the originator of the requirement is not defining the answer. He is actually defining the question, and smart procurement postulates that ... industry will team themselves with ... partners to deliver the capability that has been defined. [We] look at our research programmes as providing the knowledge, the tools and the technologies that we can access before the first [MOD] approval has to be given for any particular project, so that we are confident ... of which technologies are going to deliver success.[

202

88. We heard some fundamental concerns about the impact that a privatised DERA might have on the smart procurement initiative. The initiative seeks a closer relationship with industry, but the SBAC were concerned that a privatised DERA 'would not be motivated to support smart procurement because it would not be in the partnership between the supplier and the customer; and it would not be a source of impartial advice because it would have its own agenda for gain'.[203] GKN Westland, for example, considered it questionable whether its previous partnership with DERA in developing rotor technologies would be possible if DERA were transformed into a hard-nosed competitor for the MoD's R&D business.[204] Smart procurement should speed up the translation of technical innovation into products but the question was raised whether, with initial concept work done in DERA and industry perhaps removed from it, the traditional slowness of MoD procurement would return. [205] The onus for ensuring that any work placed with DERA does not produce 'unacceptable conflicts of interest'[206] is placed by the consultation document on the Integrated Project Team leaders. We heard doubts expressed however about whether individual IPT leaders would have the time or sufficient awareness of all of DERA's activities to be able to exercise this responsibility. [207]

89. Smart procurement anticipates significant savings for the MoD (£2 billion over 10 years). Industry argues that some of the savings anticipated should be used to bolster expenditure on the research undertaken in the early stages of equipment programmes, which is intended to help drive the initiative's emphasis on cutting delays and cost over-runs.[208] The SBAC were concerned that without adequate public investment in technology demonstration and defence research in general, the disciplines of the smart procurement initiative will drive UK equipment procurement off-shore,[209] as the required technology and equipment might only be acquired cost-effectively from overseas suppliers. They summed up their misgivings about the DERA privatisation, thus—

210

90. The public-private partnership proposals for DERA could disrupt the partnership between the MoD and industry needed for effective technology transfer and the implementation of smart procurement. After privatisation the Agency's relationships with both the MoD and industry would be compromised. A public-private partnership for DERA puts at risk the achievement of the streamlining of the acquisition process sought by the smart procurement initiative.

156 Cm 2250 op cit, para 4.9 Back

157 DERA Framework Document Back

158 HC 621 op cit, Ev p 1, para 7 Back

159 Q 228 Back

160 Q 236 Back

161 QQ 213-218 Back

162 RAE, RARDE, ARE and RSRE Back

163 DERA's establishment drew together the DRA and the Test and Evaluation Organisation, the Chemical and Biological Defence Establishment and establishments undertaking high level operational analysis. Back

164 The Defence Evaluation and Research Agency: Review of Performance, Report by the C&AG, HC 411, 1997-98, page 28 Back

165 DERA Corporate Plan 1997-2002 Back

166 Ev p 110 Back

167 HC Deb, 24 April 1998, c715w Back