Defence: expenditure delayed is expenditure denied

In an interview with Lyndal Curtis on ABC NEWS 24 on 22 November 2011 (see here) Defence Minister Stephen Smith commented on the need for Defence to contribute to the savings necessary for the government to bring the budget back to surplus:

LYNDAL CURTIS: If there are savings found in Defence will there be real savings or delaying spending? And could, if there is a delay in spending, could that create a capability gap?

STEPHEN SMITH: Well two things. Firstly, again I won’t get into the detail; people should wait until my MYEFO comes out or, in some respects more importantly, wait until the budget comes out next year before descending into the detail.

But in terms of capability as we know because you’re dealing with a big capability program and you’ve essentially got a capability plan which covers a span of a decade or more, there’s always movement, there’s always moving around. We’ve seen that in the past and there are no surprises there. And that always occurs not just under this Government but under previous Governments – I suspect it always will. What we don’t want to do is to do things that have an adverse impact on capability or on operations and I’ve consistently made it clear as Minister that if Defence does make a contribution to a general budget outcomes then that will not in any way adversely impact upon our operations. Firstly whether that’s Afghanistan, Solomon Islands or East Timor and secondly, we are always very conscious about capability; but there’s always movement on the capability front either as a result of action by industry or as a result of technical or other difficulties. There’s always movement at that station.

The Minister’s assurance that the savings will not have an adverse impact on operations is entirely appropriate and in the short run at least is entirely achievable, but that is only part of the story:

(1)    The corollary of the protection of expenditure required for operations is that the savings will come from a mixture of the capital equipment program and the budget for through life support (maintenance) of valuable, complex equipment, both of which are an essential part of capability.  This has an inevitable consequence for future operations and the military response options available to future governments.

(2)    As the Minister reminded us earlier in the interview:

In the course of the last budget, Defence effectively made a contribution of about four billion dollars over five years to help return the Government to surplus and that was as a result of more effective work we were able to do under our Strategic Reform Program.

(3)    The savings garnered under the Strategic Reform Program were to have funded the very ambitious re-equipment of the Australian Defence Force outlined in the 2009 Defence White Paper, but as the Minister’s remarks make clear, they have instead been harvested as savings.

(4) …The notion that savings merely “delay” defence expenditure (“slip everything to the right”) is a spurious one – in plain English, any savings represent a reduction in expenditure.  In last year’s Budget Defence had its budget reduced by an average of $800 million per annum for five years.  That sounds like real money to me.

(5)    Those savings and the prospect of more in the next Budget make a mockery of the “certainty” that the Rudd Government gave to Defence, in the context of the White Paper, that the Defence budget would increase in real terms by 3.3% until 2018 and 2.3% after that.

Some over-arching comments about the state of the Defence re-equipment program:

(1)    As noted in Defence savings: the impossible dream, I do not think the proposed savings are there.

(2)    Even if they were, nowhere does the Defence White Paper demonstrate that the combination of the $20 billion in savings plus the then projected growth of the Defence budget would be sufficient to cover the cost of the ambitious re-equipment program, let alone the increase in through-life support and personnel costs for an expanded and modernised defence force.

(3)    The reductions in Defence outlays only serve to take the re-equipment program even further from being achievable.

(4)    Delays in decision-making at the National Security Committee of Cabinet are further compromising the program.  To take just one example, as I remarked almost two years ago in Future submarine: no time to waste, the Government was even then bumping up against some severe timelines if it wishes to bring a replacement submarine into service in 2025.  In order to do that we would need to be undergoing sea trials in 2022, and working back from there we would need to be cutting metal in 2016.  That is no longer achievable, so the delays have already committed the Australian public and a future Australian Government to a multi-billion dollar refit of the Collins class submarines, in order to enable us to maintain a submarine capability at all – and that will be a 1990s submarine operating in the demanding environment of the 2020s.  These delays have real consequences.

I think we have arrived at the stage where we need to go back to the drawing board on the Defence White Paper and re-define what it is that we want the Australian Defence Force to do, what capabilities it will need in order to perform its allotted tasks, and what funds Government is prepared to commit to that end. Above all, the stated requirements must be backed up by the necessary resources, or they are just words on paper.

ASC is just a service provider

The government-owned submarine builder and maintainer ASC Pty Ltd is in the firing line again over the maintenance of the Collins class submarines; see for example Shake-up at navy shipbuilder by John Kerin in The Australian Financial Review, Wednesday 7 April 2010. Kerin says that ASC:

 ...has been under fire from the Rudd government and the DMO over the cost and adequacy of its maintenance of the Collins class submarine fleet.

Only three of the six Collins class submarines are capable of putting to sea, although this is an improvement on two at the end of the year.

ASC and DMO are renegotiating the terms of a 15-year, $3 billion contract to maintain the subs after accusations by DMO that ASC’s maintenance work was too costly.

It needs to be remembered by all concerned that ASC is a commercial organisation, albeit a government-owned one, which is no more than a service provider to the Defence Materiel Organisation of the Department of Defence.  Defence can have as many submarines available to put to sea as it is prepared to pay to maintain and crew. 

The facts of the matter are:

(1)  The Navy has not trained enough crew to be able to man more than three submarines, and will not be able to in the short run – see Managing the submarine workforce.

(2)  DMO has never budgeted for the maintenance of six submarines, so it is a bit rich to blame ASC for the state of the submarine fleet.  Indeed last year DMO cut the budget for submarine maintenance, and was unpleasantly surprised to discover that ASC had to lay off desperately needed skilled workers. No doubt ASC could make improvements, all industrial organisations can, but any gap between its current performance and the best that might be achievable would nowhere near account for the current state of Australia’s submarine capability.

(3)   The Defence Budget Audit made clear that maintenance program instability (in other words changing Defence requirements) were causing problems for ASC (see Future submarine and other matters).

Ultimately these factors come back to the size of the Defence budget, and the failure of Defence to manage the submarine fleet as a military capability.

Proximity is power when it comes to the bureaucratic blame game. DMO and Navy have constant access to the Defence Ministers, ASC cops the blame.

Saving money in Defence

Former Labor Member for the Federal seat of Kingston, Gordon Bilney, has an op-ed piece in today’s Australian Financial Review in which he outlines the challenges facing the Rudd Government in the year ahead.

One of these is tackling “the monstrous waste and inefficiency” at Russell Hill.

It is remarkable how many people seem to “know” that there is monstrous waste and inefficiency in the Australian Defence Organisation. Equally remarkable is how few people seem to be able actually to identify where this waste is and how it can be eliminated without impacting upon the capacity of the ADF to fight and win. Many of the solutions I see bandied about sound to me a bit like attempts to repeal the Second Law of Thermodynamics (the one which explains why only about a quarter of the energy in the petrol we buy is actually used to propel the car).

The Department of Defence, a complex organisation that consists of both its civilian staff and its “members in uniform”, receives an almost uniformly bad press. Yet somehow the civilian and military leaders of the Department manage, when requested by Government, to put into the field the right people, with the right kit and the right training, who have performed outstandingly on every deployment. Someone must be doing something right.

Waste is inevitable in every large organisation. No-one should be complacent about that: every organisation should have in place effective continuous improvement programs that seek to find better and more cost effective ways of performing all of the organisation’s functions.  But as I have commented previously, the notion on which the Government’s defence capability development plans depend, that there is an annual $2 billion of waste sloshing around the corridors of Russell just waiting for someone to harvest it, is an absolute fantasy – see Defence savings: the impossible dream and More on the Defence Savings Program for reasons why the savings are not there.

I do, however, have one very constructive suggestion for markedly reducing our defence expenditure: leave Afghanistan. No-one can articulate a convincing reason why the allied forces are there or what outcome we are looking for, and the way it has developed it has just turned out to be a very expensive way of destabilising Pakistan, a country which has never needed much help from outsiders in order to mess up its present or its future.

There is no good outcome on the horizon for the Afghanistan adventure. The most likely scenarios are a Pashtun-dominated regime led by the Taliban, or a Pashtun-dominated regime led by the Pakistani Directorate of Inter-Services Intelligence’s (ISI) warlord of choice, someone like the appalling Gulbuddin Hekmatyar.

Anyone who thinks that there is a third outcome should think very carefully about the probability and sustainability of that. If history is any guide, any non-Taliban leader in Kabul who is not ISI’s preferred option will be systematically undermined by ISI, using diverted US military assistance funds to do it, in the interests of their fantasy of becoming the dominant power in Central Asia.

Withdrawing gracefully would be a tricky business.  It must be done in a manner that does not make a bad situation worse for our allies, and that does no harm to the alliance with the United States.

That suggests that the preferred option would be to seek to persuade the United States that it is high time for everyone to recognise the realities and withdraw sooner rather than later, in as decent and orderly a manner as we can – just the topic to enliven the forthcoming Ausmin talks between our Defence and Foreign Ministers and the US Defense Secretary and Secretary of State.

 The bottom line would have to be that we are going sooner rather than later whatever the US decides to do: while we can seek to negotiate a decent and orderly withdrawal, we cannot be held hostage by our allies – and everyone understands that. If we think it is a bad idea, we have to act on that assessment, subject to decent management of the process of implementation.

The principal obstacle to moving in this direction is probably the fact that the Prime Minister has said that the war in Afghanistan is the right war, the war we have to win, and as recently as his surprise visit to the troops in Afghanistan in November declared that Australia “would remain in the conflict for the long haul”.

So the Prime Minister would have to admit that he got that one wrong, and our Prime Minister is not a person who has ever been renowned for his willingness to admit error.

Then he would have to try to convince his very good mate Barack Obama that he too had got it wrong, and we have not yet seen many signs that our Prime Minister is prepared to burn up political capital in Washington telling President Obama that he is mistaken about anything.

But how long should we tolerate having young Australians put in harm’s way in the interests of politicians’ vanity?

More on the Defence Savings Program

On the basis of the Defence Budget Audit led by George Pappas the Government has charged the Department of Defence with finding $20 billion over the next ten years to help fund the ambitious capital program set out in the Defence White Paper. Defence has cheerfully acquiesced in this, and earlier in the year the former Secretary gave everyone a “shape up or ship out” message.

Somewhere in the system there is someone who struggles with numbers, and concepts like lead times and lags.

To start with, what the Defence Budget Audit found was an estimated savings range of $1.3 billion to $1.8 billion per annum. This suggests savings over a full decade of $13 billion to $18 billion. So where did the $20 billion number come from?

The best answer seems to be by a simple summation of two numbers to be found in George Pappas’s letter to the Minister covering the submission of his report:

...Defence has committed to find the operational cost savings identified in the Defence Budget Audit, which will total $15 billion across the decade. Prior to the Audit, Defence had identified operational cost savings from individual groups and services, worth $5 billion over the decade from 2009/10 to 2018/19. These savings have been effectively integrated with or replaced by the Audit savings.

There seems to be a substantial element of double counting here: the $5 billion which had been found by Defence has been “effectively integrated with or replaced by” the savings found by Pappas’s review. We don’t know how much of the savings found by Defence were replaced by the Audit savings, but I would hazard that it is a large proportion.

Also, that $15 billion requires closer scrutiny. It sounds like a nice round number in between the upper and lower estimates, but when you take lead times into account it is right at the upper limit of what is achievable. The reason for this is:

- The Audit identifies annual savings of $1.3 billion to $1.8 billion, with a one-off saving of $218 to $398 million.

- It states (page 12) that the amount of reform required to capture these savings will take 3 to 5 years.

- If we postulate the most successful end of the range of possibilities, Defence could in three years make the reforms required to achieve the maximum annual savings of $1.8 billion per annum. If we assume that the efficiency gains from reform can be gained uniformly day by day over the three year period, the total recurrent savings in the ten year period are $15.3 billion. Add the maximum one-off saving of $400 million and we have an estimated maximum achievable amount of $15.7 billion.

- At the bottom end of the envelope of possibilities, Defence would take five years to achieve recurrent savings of $1.3 billion per annum. On that basis, again assuming uniform (straight line) progress towards the target, recurrent savings would be $9.75 billion. Add to that the minimum one-off saving of $218 million and the savings could be as little as $9.87 billion.

- It is worth bearing in mind that the achievable savings is the sum of savings identified in a large number of areas, which are stated in the form “savings of up to $x million”. For each of those components there is only a slight (indeed infinitesimal) probability of reaching the maximum number, because the assessment is that there is zero possibility of achieving more.

- To give an example, if it is estimated that a proposed series of measures would yield savings of $40-50 million, there will be a probability distribution of achieving any given sum across that range, probably highest at or near the centre of the range. Provided the measures are implemented, the assessment is that the savings would be at least $40 million – zero probability that it would be only $40 million, rising to maximum probability at around $45 million, declining to zero again at $50 million.

- What this means is that when we add a range of programs that will yield savings of “up to $x million” it is heroic indeed to postulate that the achievable savings are the sum of the maxima. It is much more likely to be the sum of the middle of each range: some programs will go close to realising their potential, others will fall substantially short.

I remain of the view expressed earlier, and from a different analysis, that finding anything like $20 billion from the Defence budget in the next ten years is an impossible dream.

For an earlier post on this subject see Defence savings: the impossible dream.

Defence Strategic Advisory Board

The Minister for Defence, Senator the Hon. John Faulkner, has announced the makeup of the Defence Reform Strategic Advisory Board that he has appointed to oversight Defence’s Strategic Reform Program, the program that is to realise savings of $20 billion over the next decade to help fund the upgraded capabilities foreshadowed in the Defence White Paper (see here for the item by Patrick Walters in The Weekend Australian, 24-25 October 2009.)

The Advisory Board, which will report to Senator Faulkner quarterly, will consist of:

- Management consultant George Pappas (Chair)

- John Fletcher, CEO of Brambles and Coles Myer

- Linda Nicholls, ex-Chairwoman of Australia Post, now Chairman of Healthscope

- Paul Rizzo, former executive of Telstra and the Commonwealth Bank

- David Mortimer, Chairman of Australia Post and Leighton Holdings

- Jennifer Clark, company director and former investment banker

- Terry Moran, Secretary, Department of the Prime Minister and Cabinet

- Ken Henry, Secretary to the Treasury

- David Tune, Secretary to the Department of Finance

- Air Chief Marshall Angus Houston, Chief of the Defence Force

- Ian Watt, Secretary, Department of Defence

- Stephen Gumley, Head, Defence Materiel Organisation.

I wonder how long it will take this high-powered team to give the Government the one piece of strategic advice it really needs – that savings on anything like the required scale simply are not there (see Defence savings: the impossible dream). Who ever dreamed up the fantasy that after making allowance for the capital spend, essential maintenance of defence materiel, the salaries and allowances of uniformed personnel, training costs, estate management costs and defence research and development, there was a cool $2 billion per annum sloshing around waiting to be harvested from whatever out of the rest might be considered non-essential expenditure?

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.

Defence reform: components of the savings

On Thursday 4 June Defence Secretary Nick Warner and Chief of the Defence Force Angus Houston jointly released a document entitled The Strategic Reform Program: Delivering Defence Force 2030. This document sets out the “Strategic Reform Program” that is intended to deliver gross savings $20 billion over the ten years to 2019. These savings are to be reinvested in military capability, remediation in previously underfunded areas, and modernisation of Defence’s “enterprise backbone”.

The document is interesting in that it nominates the areas and the amounts in which the savings are intended to be achieved:

Non-equipment procurement $4.4 billion

- Targets 23 categories of travel and training

- Better buying and contracting practices

- Centres of excellence

- 60% of savings driven by hard decisions affecting demand

Smart maintenance $4.4 billion

- Increase productivity and availability across 100 platforms and systems

- Reduce waste

- Standardise

- Provide flexibility

Inventory management $700 million

- Reduce holdings

- Improve stock

- Target setting

Information & Communication Technology $1.9 billion

- Consolidate 200 data centres to less than 10

- Create a single enterprise architecture

- Standardise Defence ICT environment

- Review the effectiveness of the two pass process for ICT projects

Reserves $380 million

- Better integration of the part time/full time capabilities

- Sponsored reserves

Logistics $320 million

- Rationalation of warehousing from 24 to 7 sites

Workforce and shared services $3.3 billion

- Civilianisation

- Conversion of contractors to Australian Public Service

- Lean administrative backbone

- Shared services

Defence Savings Program $5.1 billion

- Savings from other categories previously identified, said to be

· A general belt tightening exercise involving reallocation of funds which in the past were held centrally ($3.9 billion)

· Reductions to funding in the major capital facilities program and minor capital equipment programs, to drive greater efficiency and remove low priority activities ($750 million)

· Removal of minor administrative activities considered to be of low priority ($70 million)

· Anticipated savings from mature, ongoing productivity savings ($350 million).

In subsequent posts I will look more deeply into these components of the savings program and make some observations about the criteria for success, and the likelihood of the savings being achieved.