Shaping Future Procurement Strategies through Defence

Procurement Reform

Lieutenant- Colonel Ross FetterlyRoyal Military College of Canada

Outline• Introduction• Ship Replacement is a Recurring Investment Decision• The Importance of Capital Procurement in Defence• Major Trends Impacting on the Defence

Procurement Environment • Differences in Commercial and Naval Shipbuilding• Defence Procurement Reform– The Ability to Absorb Knowledge– Optimal Equipment Replacement Sequencing– International Collaboration– Impact on Capital Procurement from Accrual Budgeting

Ship Replacement is a Recurring Investment Decision

• Replacing the Naval Fleet of Today with the Naval Fleet of tomorrow is a recurring investment decision.

• Ship replacement has been a recurring theme in Canadian defence ever since Lord Jellicoe issued his report at the end of 1919 on alternative model fleets for the post-WW I Canadian Navy.

The Importance of Capital Procurement in Defence

“while defence policy is important, the reality is that, without equipment, one cannot even begin to implement that policy.”

Standing Committee on National Defence and Veterans Affairs (2000) Procurement Study: Report of the Standing Committee on National Defence and Veterans Affairs

The Importance of Capital Procurement in Defence

“defence capital acquisition decisions affect how well the Canadian Forces can implement defence policy. The amount and type of equipment they purchase directly affects their ability to carry out their roles, which in turn determines how and where the government can deploy them.”

Auditor General of Canada (1998) 1998 Report of the Auditor General of Canada – Chapter Four (Buying Major Capital Equipment)

Major Trends Impacting on the Defence Procurement Environment

• the elevated level of sustained Canadian participation in high-intensity international deployed coalition operations.

• the prolonged substantive involvement in international deployed operations - facilitating an ongoing shift in the Canadian Forces to an expeditionary military both in practice and culture

• procurement of capital equipment fleets not currently in the Canadian Forces inventory for use directly on international deployed operations.

Major Trends Impacting on the Defence Procurement Environment

• the long-term challenge facing both the Department of National Defence and Canadian Forces in advancing an ambitious capital equipment program while simultaneously integrating numerous replacement generation fleets into operational units.

• the rapidly growing demand for replacement equipment parts, as well as capital equipment repair and overhaul contracts.

• the emerging, and not yet clearly recognized, shift in the capital equipment budget from its historical residual status within the overall defence budget to that of a primary and sustained focus of defence resource allocation decision-making.

Differences in Commercial and Naval Shipbuilding practices

• differences are quite pronounced in the size and complexity of the two different types of ships, with commercial vessels several times the size of warships yet much less complex than military ships.

• Requirements for both leads to differences in design; naval ships are filled with advanced equipment and technology, as well as the requirement for a much more rigorous testing and evaluation regime.

• the difference in ship dimensions and sophistication requires naval vessels to have a more skilled construction and maintenance workforce that is also geared towards a greater level of engineering support.

Differences in Commercial and Naval Shipbuilding practices

• Contracts for commercial shipbuilding focus on incentives towards ensuring on-time delivery of the ships, whereas for military contracts, payments are made to the manufacturer following specific milestones.

• Although commercial shipbuilders generally build their ships from established designs, the design of naval vessels by both class and nation tends to vary.

• while commercial vessels of various size and specialization are produced in large quantities from essentially standard designs, naval vessels are generally designed independently and produced in small numbers.

Industry and the Naval Shipbuilding Market

• Industry reliance only on government shipbuilding contracts is not a stable business model.

• From the perspective of industry, the regularity of naval shipbuilding contracts is not steady, and future plans for naval contracts are uncertain and often subject to change.

• The uncertainty of future naval shipbuilding contracts acts as a constraint on the willingness of firms in the industry to invest in modernization of ship yards and to increase skills in their labour force.

• Industry perceives contractual requirements of governments, together with regulatory regimes and statutory requirements, as an increasing burden.

Defence Procurement Reform

“While DOD maintains military forces with unparalleled capabilities, it continues to confront pervasive, decades-old management problems related to its business operations – which include outdated systems and processes – that support these forces.”

United States Government Accountability office (2009) Defense Logistics – Lack of Key Information May Impede DOD’s Ability to Improve Supply Chain Management

Defence Procurement Reform

“there are certain common characteristics of successful commercial and governmental projects. Short, unambiguous lines of communication among levels of management, small staffs of highly competent professional personnel, an emphasis on innovation and productivity, smart buying practices, and, most importantly, a stable environment of planning and funding-all are characteristic of efficient and successful management.”

1986 President’s Blue Ribbon Commission on Defense Management - An Interim Report to the President

Knowledge Management

• As a consequence of an increasing use of technology, defence departments will need to employ an anticipatory approach to defence procurement that is based on developing new concepts, incorporating emerging technologies, and adapting to emerging business practices.

• In their seminal paper on absorptive capability, Cohen and Levintal (1990) demonstrated that “prior knowledge confers an ability to recognize the value of new information, assimilate it, and apply it to commercial ends.”

The Ability to Absorb Knowledge

• Although the necessity to remain aware of substantive industry developments and technology capabilities is not new, the demands of the international strategic environment have changed, reinforcing the importance of this institutional capability.

• Contributors to organisational innovation are:– Knowledge acquisition– Knowledge dissemination– Knowledge utilization

Optimal Equipment Replacement Sequencing

• Greenfield and Persselin (2003) developed an economic framework to identify optimal replacement strategies for aging aircraft fleets. They employed cost trade-offs and incorporated age effects in their methodology. This publication provides a theoretical foundation that can be applied in decisions on when to replace aging military equipment fleets.

• In a recent DND study by MayBury, (2009), he utilised data from the CP-140A Arcturus maritime surveillance aircraft and developed a model that “signals replacement, modernization, or a “reset-the-clock” overhaul to decision makers.” This model acknowledged the value in delaying replacement decisions in order to increase the information available for decision makers. The approach taken recognises that defence departments will make a range of decisions on different equipment fleets.

A Disciplined Approach to Decision-Making

“At the program level, the key cause of poor outcomes is the consistent lack of disciplined analysis that would provide an understanding of what it would take to field a weapon system before system development.”

United States Government Accountability Office(2008) Defense Acquisitions - Better Weapon Program Outcomes Require Discipline, Accountability, and Fundamental Changes in the Acquisition Environment

International Collaboration

• International collaboration in defence procurement is frequently recommended, yet in practice has been adopted infrequently by governments when compared to national projects.

• Nevertheless, a number of other influential factors are now converging should result in an increase to international collaboration in multi-billion dollar defence projects in the future.

International Collaboration“The prevalence of extremely high costs and low scales of

production in the development and production of complex RMA weapon systems means that increasingly numbers of countries are unable to afford self-sufficiency. Thus, defence globalization is forcing a reverse process, whereby self-reliance is no longer the goal, with acquisition instead geared toward international collaboration, and increasingly, outright purchase.”

Ron Matthews, Ron (2006) “Smart Management of Smart Weapons” in Studies in Defence Procurement – Claxton Papers 7 pages 75-94 (Queen’s University School of Policy Studies).

International Collaboration

• When viewed from a broad perspective, the economics of defence globalisation has become the main factor in securing cost reductions in defence procurement. As a consequence, economics appears to be competing with the demands of defence-industrial sovereignty.

• Despite the fact that the United States has been investing in arms procurement at a rate of approximately 3:1 compared to the combined European total, the American Department of Defense is also finding it difficult to unilaterally develop and field a broad range of weapon systems.

Impact on Capital Procurement from Accrual Budgeting

• The historical practice in Canada has been to support current operations (the present force) at the expense of investing in capital equipment (the future force).

• This practice resulted in capital equipment expenditure in the defence budget being treated as a residual.

• While this effectively supported in-year activities, it had a detrimental effect on the long-term capital investment program in-year despite substantial over-programming. This surplus was effectively absorbed by the extent of operations and maintenance expenditure incurred by the department.

• The adoption of accrual accounting by the Department of National Defence is dramatically changing this entrenched sub-optimal dynamic.

Impact on Capital Procurement from Accrual Budgeting

• The explicit decision to re-balance defence resource allocation – in contrast to past precedent – to address the chronic underfunding of capital procurement is perhaps one of the most consequential decisions since the decision to integrate the Canadian Forces during the Hellyer Era.

• The impact of managing the capital program under full accrual accounting is that it changes longstanding patterns of institutional behaviour.

• Slippage in the planned capital program is now being re-profiled; funds are moved to the subsequent fiscal year and remain within the capital investment envelope. This is a major contribution to the long-term ability of the Canadian Forces to maintain modern and capable equipment fleets.