16 September 2009

Defence savings: the impossible dream

In Defence White Paper: an appraisal, Defence Savings: The Strategic Reform Program and Defence White Paper: the numbers do not add up I raised doubts about the extent to which it will be possible for Defence to find the projected net savings of $20 billion which it is required to find from within its own budget as a contribution to the defence capability upgrade contemplated by the Defence White Paper.

These analyses are up on the web for all the world to see, but the message hasn’t got through yet. Indeed, in today’s (16 September 2009) edition of The Australian Financial Review we are told by defence writer John Kerin that

Prime Minister Kevin Rudd has ordered the Department of Defence to report to Cabinet’s powerful national security committee twice a year on efforts to curb cost blow-outs and delays on big ticket military projects and to realise a separate $20 billion cost-cutting program.

The directive follows the government’s introduction last year of a series of sweeping reforms to defence procurement in an effort to improve management of defence projects, with up to $275 billion in new equipment spending planned over the next 20 years.

Mr Rudd is determined to ensure defence delivers on the government’s $20 billion strategic reform program (SRP) over the next 10 years. The wish list of new weapons, including new submarines and jet fighters, is predicated on the realisation of the savings plan.

Because Defence has a poor record on past efficiency drives, government sources say the new reporting arrangements are designed to keep pressure on the wasteful department.

These bi-annual reviews are going to produce deep disappointment. Here’s why:

(1) In relation to procurement process I will confine myself here to saying that in DMO: What was all the fuss about? I noted that 66% of the reasons for delay on major projects are beyond the control of the Defence Materiel Organisation (DMO), and 83% of the over 200 Defence acquisition projects closed over the last ten years were on or below their approved budget. Not much scope for huge improvement on the acquisition side.

(2) Regarding the aspirations of the SRP, the task is to find $20 billion of net savings over the next ten years. The size of the “Defence budget” is a matter of some technical debate. Let us be generous and say that for 2009-10 it is the amount appropriated by the Parliament plus the unspent moneys available from previous years. This amount is $25.54 billion.

The Government’s guidance is that this expenditure will be increased in real terms by 3% per annum until 2018, after which it will be increased by 2.2%. If you do the sums that means that the total Defence budget for the ten year period is $292.5 billion 2009 dollars. This means that the net savings to be found amount to 6.84% of the total budget.

(3) The problem is that “efficiency” savings can only be found from within the recurrent budget. The 5-year Defence Capability Program (DRP) commits the Government to capital outlays of $60 billion. Let us assume for the moment that the savings can be made at no cost (i.e., $20 billion of savings can be found without making any outlays whatever), and that there is no capital expenditure whatever in the second half of the ten-year period. That leaves us looking for $20 billion out of $232.5 billion, a target of 8.6% of outlays.

(4) Of course it is ridiculous to postulate no capital expenditure in the second five-year period – the whole aim is establish an increased investment program, and a better but conservative assumption would be that the expenditure in the second five years is not less than the $60 billion committed for the first five. That makes a total expenditure on new equipment of $120 billion in the first ten years of a $275 billion 20-year program. It leaves us looking for $20 billion of savings out of $172.5 billion, a target of 11.6%.

(5) This might sound like an achievable target if indeed the Department is as “wasteful” as everyone claims, which I would dispute. There are savings to be had, but not of that order.

(6) The killer problem is that savings are not achievable for nothing. Indeed, in a speech to the Australia and New Zealand School of Government on 13 August, Senator Faulkner revealed that repairing Defence’s “broken spine” (obsolete IT systems etc.) will cost $30 billion over the next decade. So in order to find net savings of $20 billion over the next decade, Defence will have to find gross savings of $50 billion out of that $172.5 billion, a target of 29%.

(7) It gets worse. Salaries and allowances have to be paid out of that $172.5 billion. Personnel expenses for Defence including DMO in 2009-10 will be around $7.9 billion, rising to $10 billion in 2012-13. Of course an important objective of any savings program is to find more efficient ways of doing things, and thereby find personnel savings. The whole objective in Defence, however, is to maintain a Defence Force of a size determined by Government, so better ways of doing business within the uniformed branches might yield personnel available for redeployment to more productive pursuits, but they do not yield cost savings. Savings can only be found from within the civilian workforce, and the military personnel costs must be deducted from the sum within which we can look for cost savings.

Budgeted expenditure on military personnel amounts to $7.28 billion in 2009-10, rising to $7.98 billion in 2012-13. As the per capita cost of military personnel is rising in real terms it is reasonable to take that $7.98 billion figure for the fifth year of the ten as a rough average of the annual expenditure on military personnel and say as a ballpark figure that we will be spending $80 billion over the decade on the personnel costs of the Army, Navy and Air Force.

This means that we are now looking for gross savings of $50 billion out of $92.5 billion, or 54%. Net savings amount to 21.6%. Best of luck.

(8) These calculations are a bit rough and ready. It could be objected, for example, that there is an operating costs component in the capital budget – salaries, travel and other costs of Defence personnel directly engaged in acquisition projects. These are a fair target for efficiency gains.

In 2009-10 these operating costs amount to 7.8% of the Capital Investment Program, an unusually high figure. The average for the first five years of the ten-year SRP timeframe is about 6.0%. If we reallocate 6.0% of the assumed $120 billion capital spend (i.e. $7.2 billion) to the amount from which we are seeking savings, we will be looking for gross savings of $50 billion from an amount of $99.7 billion, or 50.2%.

(9) That is not the end of the story. From that sum of $99.7 billion we must find the money for Fuels and Lubricants ($476 million in 2009-10), Explosive Ordnance ($345 million in 2009-10), ADF Clothing and Equipment ($116 million in 2009-10) and a range of other operating costs: ADO Commercial Fleet, Wide Area Surveillance, Battlespace Communications, management of the largest real estate portfolio in the country, etc.

The conclusion is inescapable. Whoever has advised Government that they can find $20 billion of savings simply hasn’t done the sums.

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