18 May 2009

AWD: who is building those ships?

There is an intriguing report by Mark Ludlow in the Weekend Australian Financial Review, 16-17 May 2009, concerning the selection of AIMTEK Pty Ltd (trading as NQEA) as a preferred supplier for a $450 million contract for the construction in Adelaide of the Navantia-designed Air Warfare Destroyers (“Defence chief sticks to his guns”).

What is remarkable is not just the fact that the company has been selected notwithstanding a warning from the Queensland Government that “the company had financial problems”. What is more remarkable, and just as disturbing, is the fact that one of the hardest-learned lessons from the construction of the Collins Class submarine seems to have been forgotten already.

That lesson is that Government intervention in the decision making processes of the company awarded the responsibility for the project has the potential to create highly unsatisfactory outcomes, combined with a diffusion of responsibility for those outcomes.

Specifically, there was a problem with the way Defence approached the combat system for the new submarines. In effect, Defence made the development of the combat system a separate project from the development of the submarine itself; the two would be integrated later. The aims for the combat system were very ambitious. As Defence Minister Kim Beazley said in his May 1987 media release announcing the contracts, “The computerised combat system will be more advanced than any yet installed in a diesel-electric submarine”.

Unfortunately, in attempting to implement this ambitious vision, Defence itself selected the sub-contractor that was to build the combat system, and imposed that sub-contractor (a consortium led by Rockwell) on the Australian Submarine Corporation (ASC), which had the prime contract to build the submarine.

The unsatisfactory outcome of that approach was described by Peter Yule and Derek Woolner at p.156 of their excellent history of the Collins project (The Collins Class Submarine Story: Steel, spies and spin, Cambridge University Press, 2008) in the following terms:

The structure of the contract for the combat system was unusual and bitterly opposed by both ASC and the Rockwell consortium. Essentially the Commonwealth forced contractual responsibility onto ASC, though it neither chose the sub-contractor nor knew, for security reasons, the specifications of the system. ASC was responsible for the successful delivery of the combat system, but it had limited ability to ensure that this happened. Just the night before the contracts were signed, Rockwell was pushing to have a contract directly with the Commonwealth, not wanting to be subservient to a fledgling prime contractor...

This shotgun marriage very definitely ended in tears. ASC had full warranties and bank guarantees from Rockwell worth hundreds of millions of dollars that it would deliver the combat system before September 1993, but in order to be able to enforce those warranties it was required by the contract to issue a default notice before 9 September 1993. This the ASC Board decided to do, shortly before the deadline. When the Secretary, Department of Defence was advised of this by the company chairman, he gave the latter a dressing down, and on 1 September the Department wrote to the company instructing it to accept incremental delivery of the combat system (see Yule & Woolner, pp 198-200). This meant that ASC lost its right to default Rockwell and therefore the only power it had over the sub-contractor.

When I became Secretary in 1998, HMAS Collins and HMAS Farncomb had been commissioned, but the Department was still wrestling with the problem of how to deliver an adequately functioning combat system.

For the Air Warfare Destroyer project, the envisaged solution to the acrimonious relationship which developed between the Defence Materiel Organisation (DMO) and ASC in relation to the Collins class submarines seems to have been the creation of something called the Air Warfare Destroyer Alliance. There is a description of the Alliance and its rationale here.

What we are told is that the Government directed “an innovative alliance based strategy for the AWD project”. I am all in favour of a risk sharing approach to these complex and technologically demanding projects, but there is some language in the rationale for this particular alliance that sets alarm bells ringing. In the description of the principal benefits of the alliance approach we are told that “risks and responsibilities are shared collectively”, and that “profits (gain) and losses (pain) are shared equally between government and industry”.

Unfortunately, we are also told that “under the Agreement the industry participants are responsible for delivering the AWDs on time and on budget”. How can this be if risks and responsibilities are shared, and in other parts of the rationale there is language about “the removal of scope boundaries between the participants”, and we are told that “government has retained key controls including the power to ‘step in’ and complete the project if required”?

So what do we have here? Do we have a genuine alliance contract of a type that would be recognised by industry, or is ASC yet again in effect a prime contractor that will be held to its contract, notwithstanding intervention by the Commonwealth in the way the contract is implemented? Why is the Commonwealth a participant in the selection of ASC’s subcontractors, and why is the Minister for Defence announcing the successful tenderers? How can ASC be held accountable for the project outcome if this is the case?

More to the point, if this one ends in tears, if for example NQEA fails to perform, can we look forward to the Minister and Head, DMO accepting co-responsibility with ASC for that?

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