Is there anything to learn from defence procurement savings?

6 May 16

In May 2014, the Defence Reform Act passed into law and ushered in radical changes in defence procurement. Two years on, are there lessons to learn for other areas of taxpayer-funded purchasing?

The RAF's first A400M transport plane - image: MoD

Unveiling of the RAF's A400M transport plane in November 2014 - image: MoD

 

The Single Source Regulations Office (SSRO) regulates the Ministry of Defence’s non-competitive procurement of equipment, goods and services. Such single source procurement can be necessary where there is only one supplier with the necessary capability, for example, or to maintain skills within the UK that are essential for the nation’s defence. We have two main aims: firstly to ensure that the suppliers are paid a fair and reasonable price and secondly to ensure value for money for the taxpayer.

The regime for managing single source defence procurement had changed little for half a century and the SSRO has faced the challenge of changing ingrained attitudes and behaviour as well as that of developing new, more appropriate arrangements for procurement. That has taken time but there are clear signs of progress.

One of our statutory duties is to recommend a baseline profit rate to the Secretary of State for Defence, to be used for all qualifying contracts worth over £5m. The profit rate for these contracts has been reduced by close to 20%, which has been acknowledged by both the OECD and HMRC as the largest single change following a move towards a methodology linked to transfer pricing. The baseline rate for this year of 8.95% is a reduction from 10.6% for the year 2015-16.

The other key area of change has been our new guidance on what kind of costs incurred by companies may be passed onto the taxpayer through single source contracts. This guidance is statutory and both contracting parties have to take account of it when determining whether costs are allowable. The guidance is based on principles rather than rules and the key criteria are whether the cost is appropriate, attributable to the contract, and reasonable in the circumstances. The onus to provide sufficiently compelling evidence that these criteria are being met lies with the company rather than with the Ministry of Defence.

The value of qualifying defence contacts is substantial: the annual spend on defence single source contracting is estimated at £8.3bn and the SSRO currently has oversight of contracts worth over £10bn in total. We have already removed close to £2m in charges for faulty workmanship, labour inflation, entertaining, understated learning curves, and sales and marketing. We have a further £57m currently under review. In addition, we know that the very presence of the guidance has resulted in costs being excluded which would previously have been added to contracts.

If a disagreement on costs can’t be settled through negotiation, the Defence Reform Act provides the SSRO with the power to issue a legally binding determination, which both sides in the dispute – the Ministry or Defence and the defence contractor – must comply with.

We originally published our guidance on Allowable Costs in January 2015, after widespread consultation. From our experience to date, it is clear that further clarification is needed in some areas, so we are currently consulting on what amendments or additional information should be incorporated into the next edition, which we are aiming to publish in July.

So, it is evident that the existence of a regulator which works closely with industry and provides clear and comprehensive guidance leads to more efficient single source procurement, and saves the taxpayer money. However, defence is not the only area of public procurement where single source contracting exists – a point recognised in countries such as Germany, where a common set of regulations applies to all public sector single source procurement. This regime is enforced with heavy penalties for non-compliance.

Of course, different sectors and different countries have their own particular requirements, but is it time to think again about how single source public sector contracts are managed in the UK – including what lessons there are to learn from the experience of the SSRO?

More details about the consultation, which closes on 1 June, are available at the SSRO website.

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