Report

by the Comptroller
and Auditor General

Ministry of Defence

Major Projects Report 2014 and the Equipment Plan 2014 to 2024

HC 941-I Session 2014-15 13 January 2015

Our vision is to help the nation spend wisely.

Our public audit perspective helps Parliament hold government to account and improve public services.

The National Audit Office scrutinises public spending for Parliament and is independent of government. The Comptroller and Auditor General (C&AG), Sir Amyas Morse KCB, is an Officer of the House of Commons and leads the NAO, which employs some 820 employees. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether departments and the bodies they fund have used their resources efficiently, effectively, and with economy. Our studies evaluate the value for money of public spending, nationally and locally. Our recommendations and reports on good practice help government improve public services, and our work led to audited savings of £1.1 billion in 2013.

Ordered by the House of Commons

to be printed on 13 January 2015

This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act

Sir Amyas Morse KCB
Comptroller and Auditor General
National Audit Office

8 January 2015

This volume has been published alongside a second volume comprising of – Ministry of Defence: Major Projects Report 2014 and the Equipment Plan 2014 to 2024 (Appendices and project summary sheets) HC 941-II

This year for the first time we are combining what have previously been 2 separate outputs, the Major Projects Report and our review of the affordability of the Equipment Plan.

© National Audit Office 2015

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10576 01/15 NAO

The National Audit Office study team consisted of:
Sarah Bryant, Jackie Chu, Jeremy Gostick, Helen Holden, Matt Hemsley, Rachel Hollway, Michael Slater, Mohammed Surti and Martin Wheatley, under the direction of Lee Summerfield.

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Summary

Scope of the report

1 Since 2012, the Ministry of Defence (the Department) has published an annual Statement on the affordability of its 10-year plan to deliver and support the equipment that the Armed Forces require to meet the objectives set out in the National Security Strategy.1 We report on the robustness of the assumptions underlying the Statement.

2 Each year the Department also presents to the Committee of Public Accounts a Major Projects Report which provides data on the cost, time and performance of the largest defence projects.2 We review the information underlying in-year variations to cost time and performance.

3 The Equipment Plan is the Department’s forecast budget to cover the costs of procurement and support of military equipment for the next 10 years. In 2012, the Department adopted a new approach to generate greater stability in its procurement activity by developing a budget for a ‘core programme’ of key equipment projects, with additional sums set aside for contingency and emerging requirements. It is updated annually. For the period 2014 to 2024, the equipment budget is £163 billion, made up of procurement (£69 billion) and support (£81 billion) budgets, a central contingency reserve (£4.6 billion), and an unallocated budget (£9.2 billion) that the Department has not yet committed to specific programmes. The Plan is funded from the Department’s overall budget, and makes up a significant proportion of its planned spend.

4 For the first time we have combined our review of the Equipment Plan with the Major Projects Report, to enable Parliament to have a more complete view of the Department’s management of the procurement and support of the UK’s defence capability. We have selected a sample of 17 projects as the basis for reporting project performance and to support our review of the affordability position.3 This sample of projects has been selected based primarily on value but also to reflect the level of project maturity and type of equipment.

5 We do not set out to offer a definitive view on the affordability of the Equipment Plan, as it is, by its nature, based on assumptions about the future that will inevitably change. Rather, we review the assumptions that underpin the forecast costs and funding to assess whether they were reasonable and consistently applied at the time they were made. We explain our approach in Part One of this report, and then look at: the Department’s assumptions underpinning the forecast costs of the Equipment Plan (Part Two), including for the first time this year support costs; and the assumptions underpinning available future funding (Part Three), which taken together define whether the plan is affordable. We have also reviewed whether the disclosure in the Department’s Statement is sufficient for the reader to fully understand the risks and sensitivities of the affordability position (Part Four). Appendix One contains full details of our audit procedures, and Figures 12 and 13 provide an overview of the projects included in our analysis. Summaries of the projects in our sample are included at Appendix Four. The full set of information for each project is set out in the project summary sheets completed by project teams which are included as Volume II of this report.

Confidence in the continued affordability of the Equipment Plan as a whole

6 The forecast cost of the Equipment Plan 2014 to 2024 is £1.4 billion less than the forecast cost of the 2013 to 2023 Equipment Plan. The forecast cost of the Plan for 2014 to 2024 is £162.9 billion compared with £164.3 billion for the period 2013 to 2023 (see Figure 1). Since 2012, the Department has emphasised the importance of the affordability of its core equipment programme. For the Department to have confidence that the Equipment Plan is affordable, the combined cost forecasts for its core programme of projects need to be contained within the sums made available by HM Treasury, allowing for the non-equipment commitments of the Department.

7 There have been significant movements of funds between procurement and support budgets. Compared with the 2013 Plan the forecast cost of procurement has increased by £5.4 billion while support costs are expected to be £6.2 billion less over the period. This is due mainly to: a reclassification of costs for one project as procurement rather than support; and anticipated efficiency savings in the support budget more generally. Anticipated efficiency savings are the main cause of a £5.8 billion decrease in the Equipment Plan budget across the 9 years that the 2013 and 2014 Plans have in common (2014 to 2023).

8 The Department has removed more than £6 billion from budgets within the Plan in anticipation of achieving significant savings. The largest element of this is the removal of £4.1 billion of anticipated savings from the support cost budget. The Department has engaged external consultants to assist in identifying savings. They have reviewed 11 major support projects to date, constituting nearly 40% of the value of the equipment support programme. The project teams have provisionally identified potential savings of £2.9 billion over 10 years. Only a limited proportion of these savings have been realised to date. Savings have also been removed from procurement budgets:

Savings of £1.05 billion expected through the Submarine Enterprise Performance Programme.

£1.2 billion of savings to be found from the Complex Weapons procurement programme.

If savings are not achieved the Department will need to adjust its budgets, which could mean using money set aside for future projects, or delaying or cancelling existing projects.

9 Project teams continue to be over-optimistic in their forecasts of both procurement and support costs. Project teams continue to be over-optimistic in their forecasts of procurement costs. The Department’s Cost Assurance and Analysis Service estimates that the forecast cost of procuring equipment is understated by £3.2 billion against project team forecasts, a reduction from £4.3 billion for the 2013 to 2023 period. The Cost Assurance and Analysis Service has also reviewed 28% of the support cost budget to date, and estimate that project team forecasts for those projects are £2 billion understated.

10 Budgets set using over-optimistic forecast costs could result in overall budgets for procurement and support being significantly understated. The Equipment Plan budget should be a compilation of the individual budgets that are set based on the estimated forecast cost of each project. In some instances, however, the budget may be set lower than this; for example where the Department is challenging project teams to deliver projects for less. A review of the estimated procurement costs of 29 of the largest projects within the Plan by the Cost Assurance and Analysis Service in January 2014 initially estimated the gap between the allocated budget and the realistic procurement costs of these projects to be some £4.7 billion. In April 2014, the Department adjusted its budget allocations, adding £2.4 billion to the 2014 Equipment Procurement Plan. There is currently no overall estimate of whether, or to what extent, support budgets may be understated.

11 The Department’s contingency may not be enough to mitigate the combined effects of underestimates in project team costs and equipment plan budgets. The Department continues to hold a £4.6 billion contingency across the 10-year plan to mitigate potential cost increases within the core equipment programme. Should this contingency be insufficient to mitigate unrealistic forecast costs across procurement and support budgets the Department may need to draw on the £9.2 billion that is set aside to deliver equipment needed for delivery of wider defence capability that currently is not included in the core programme.

12 The Department’s Statement on the Affordability of the Equipment Plan is clearer than the earlier two Statements. The reader can understand how the Equipment Plan is constructed, managed and challenged. However, the Statement needs to be improved further to explain more clearly the key assumptions and the risks to the affordability of the Equipment Plan. In particular, more information is needed on how to measure the success of initiatives to achieve support cost savings, and how to manage the Equipment Plan if the necessary level of savings is not met.

Confidence in the Department’s delivery of major projects

13 Our review of the forecast cost of 11 major projects where the Department has decided to buy equipment shows that the time, cost and performance of these projects has remained stable in 2013-14. For the 11 projects within our sample of 17 projects that have passed the main investment decision, the forecast cost of the projects has reduced by £397 million (0.7%). This was largely due to a reduction in the forecast cost for the Lightning and Typhoon fighter jets. There has only been one new significant approval during 2013-14 and no new procurements have been introduced, resulting in a relatively stable portfolio of major projects. We have excluded the £754 million cost increase of the Queen Elizabeth Class Aircraft Carriers, which we reported in our Major Projects Report in February 2014. The Department expects the projects to achieve 99% of their intended capability. There were in-year time variations totalling 14 months for 2 out of 10 projects – for Warrior Capability Sustainment Programme and Core Production Capability; in both cases the Department does not expect any impacts on operational capability from these delays.

Confidence in the forecast costs of the largest projects

14 Increases in the forecast costs of projects are not due to real cost growth and forecast costs largely remain stable across projects. Alongside our review of the aggregate cost movement from the prior year, we also undertook a detailed review of 17 of the largest procurement projects to see whether there was cost stability at the project level. We found that the 10-year procurement cost of these projects increased by £2.6 billion compared with the forecast cost for 2013 to 2023. However, these increases mostly came from the Department:

implementing some projects within the 10-year plan more quickly, thereby bringing costs into the plan earlier; and

assessing that it would be more appropriate to classify some costs as procurement rather than support.

15 The Department overspent by £185 million against its original equipment budget in 2013-14 by tasking project teams with a large amount of additional work. The Department has taken action to manage the risk of underspending against its budget, as in past years. To avoid a significant underspend in 2013-14 the Department included £920 million of additional work in the programme. When the Department became concerned that an underspend would emerge in-year, a further £213 million of additional work was added to the programme. In the event, the Department overspent by £185 million against its original assumptions. In 2012-13, we reported that the Department underspent on equipment by £1.15 billion against the total value of its work programme for the year (original equipment budget plus additional work programmed during the year). For 2013-14, the equivalent figure was £948 million.

16 A detailed review into the causes of project underspends shows that the largest single cause is accounting adjustments. Errors and consequent adjustments involve movements of hundreds of millions of pounds within budgets. This can give a misleading picture of spend and forecasts at individual project level. It is clear that the Department needs to improve its in-year financial management. The Department recognises the need to continuously improve its in-year financial management and has established a programme to do so. In addition, external consultants working with the Department to review support costs have found consistent weaknesses in:

specifying requirements;

estimating costs; and

working with suppliers to drive down costs.

17 Project teams have varying skill levels in cost forecasting and risk management. Only 9 of our 17 projects forecast a range of potential costs based on the likelihood of different scenarios and risks, in line with good practice. Sometimes project teams rely on industry to model realistic cost estimates for projects. This casts doubt on whether the forecast costs are sufficiently robust for the Department to have confidence that the Equipment Plan is affordable and the Department has sufficient quality of information to manage the risks to the budget.

18 Project teams need to ensure they are using the most appropriate inflation rate. The forecast costs of long-term projects can be significantly affected by the projected inflation rate. Unexpected changes in inflation may drive cost increases in projects beyond those that were planned for, so project teams should understand how their projects are affected by inflation. The Department’s guidance states that project teams should apply an inflation rate that is suitable to the characteristics of their projects, which is a reasonable approach. However, in 4 projects we found that teams were using rates based on analyses from 2 to 3 years ago or were applying a general rate without evidencing that this was appropriate. We would expect an up-to-date, evidence-based rate to be used to mitigate the effect of unexpected inflation rate movements.

Confidence in the funding assumptions of the Equipment Plan

19 The Department believes it is making the necessary savings in non-equipment budgets to protect the Equipment Plan, but we have not reviewed these. Funding for the Equipment Plan is not protected; the Department has to allocate its budget for equipment costs internally, ensuring that there is also enough within the budget to meet non-equipment cost (such as the management of the Defence Estate and costs of Armed Forces personnel). The absence of savings in these budgets could increase the proportion of the defence budget that is needed in those areas and have an impact on the funds available for the Equipment Plan.

20 The Department believes that the fundamental assumptions underlying the affordability of the Equipment Plan have not changed since last year. These assumptions are that a fixed minimum value will be given for the funding of the Equipment Plan for each year in the period covered, based on a 1% real increase above inflation (although this is not guaranteed for the full period of the Equipment Plan). Also, the Department can choose to spend more than that on equipment procurement and support, and the current Equipment Plan budget is significantly in excess of the amount allocated by HM Treasury for equipment procurement.

Conclusion

21 There are a number of positive features arising from our work on the Equipment Plan, not least the relative stability of forecast project costs and control over in-year variations in approved timings and costs of major projects. The Department has chosen a higher risk approach to managing the affordability of the Equipment Plan by relying on future savings where a significant proportion has not yet been identified. This is within the context of potential continuing over-optimism in the project cost forecasts that make up the Plan. The Department will need to be watchful and quick to react if costs start to grow.

1 HM Government, A Strong Britain in an Age of Uncertainty: The National Security Strategy, Cm 7953, October 2010.

2 The project summary sheets the Department submits to Parliament are contained in Volume II of this report.

3 We also looked at the assumptions underlying a small additional sample of support projects.

Part One

Affordability of defence equipment

1.1 The Ministry of Defence’s (the Department’s) annual Equipment Plan sets out its expenditure plans for the equipment the Armed Forces need to meet the objectives of the National Security Strategy4 and the Strategic Defence and Security Review5 over the next 10 years. From 1 April 2014 to 31 March 2024, the Equipment Plan has a total budget of £163 billion for:

equipment procurement (£69 billion);

equipment support (£81 billion);

a contingency provision (£4.6 billion); and

an unallocated budget of £9.2 billion, consisting of £8 billion of ‘headroom’, which has previously been apportioned to commands from 2017-18, and £1.2 billion earmarked for future long-term equipment needs.

1.2 Many defence projects extend beyond 10 years, so the Equipment Plan does not cover the full procurement costs of its projects. Each year the Department also presents to Parliament a Major Projects Report. This gives data on the cost, time and performance of the largest defence projects where the Department has taken the decision to proceed to the main demonstration and manufacture stages of the project. There is no restriction to a specific period. Less detailed information is also given about the largest projects where the decision has not yet been taken, but work is ongoing to inform this decision.

A single overview of the Department’s progress in implementing major projects and programmes

1.3 Both the Department’s Statement on the Affordability of the Equipment Plan and the data in the Major Projects Report outline the progress of the Department’s programme of equipment procurement. However, the Equipment Plan is based on the detailed 10-year forecast. The Major Projects Report is focused largely on costs that have been approved by the Department’s Investment Approvals Committee. It excludes unapproved costs. Therefore each dataset presents one unique perspective.

1.4 In this report we use information from both the Equipment Plan and Major Projects Report to present a full overview of the Department’s major procurement programmes. Small changes to planned cost and delivery on programmes can have an impact on the affordability of the Equipment Plan. By combining the two pieces of work, we can assess whether the performance of the projects supports the view that the Equipment Plan is affordable. Both the Equipment Plan and the Major Projects Report outline the procurement costs. Parliament can then decide whether the Department’s approach to the Equipment Plan is adequate.

1.5 This report examines whether:

the costings in the Equipment Plan were based on broad assumptions that were reasonable and consistent. This includes how changes to the cost, time and performance of major projects beyond the 10-year period relate to overall affordability (Part Two). It draws on our examination of the data in the Department’s Major Projects Report (summarised in Appendices Two and Four);

the assumptions used in forecasting the total funding available to the Department and the funding allocated to the Equipment Plan are realistic (Part Three); and

the Statement contains enough appropriate information to make the reader aware of:

the key assumptions and risks; and

how much the assumptions would need to change for the Equipment Plan to become unaffordable (Part Four).

Our approach

1.6 To support our review of the assumptions that underpin the forecast costs of the Equipment Plan, we looked in detail at 17 of the Department’s largest procurement programmes and 5 support programmes. For the sampled projects we looked at the reasonableness and consistency of assumptions used to forecast the 10-year costs. For the 17 procurement projects we also looked at the progress of cost, time and performance against the original approvals (that being the data included in the Major Projects Report). Summaries of the projects in our sample are included at Appendix Four. The full set of information for each project is set out in the project summary sheets completed by project teams which are included as Volume II of this report.

1.7 Our approach to examining the procurement and support projects 10-year Equipment Plan was to look at the audit evidence that the costs are sufficiently robust for planning purposes through a review of: the cost modelling; risk management; the Department’s own assurance processes; and in-year performance against budget. We also worked closely with the Cost Assurance and Analysis Service to understand the work they have done through their independent cost reviews and estimates, both for the projects we sampled but also on the wider Equipment Plan, as well as their cost forecasting work on behalf of project teams.

1.8 The Equipment Plan covers a 10-year period, whereas project approvals can be for a longer period, as illustrated in Figure 2 which shows the cycle of the procurement projects and the subset of costs that are included in the 10-year Equipment Plan. The sample of support costs is shown in Appendix Two.

The path to a reasonable assurance engagement

1.9 We aim to gradually expand the scope of our review so that the Comptroller and Auditor General is able to rely on the Department’s controls over the affordability of the Equipment Plan. We will use a framework based on international accounting standards to achieve this. Having evidence of strong controls in place will allow the Department to show stakeholders, particularly industry, that it is negotiating from a stable and credible position. We will review the Department’s progress in addressing the key risks to the affordability of the Equipment Plan as set out in our previous reports (Appendix Three).

4 HM Government, A Strong Britain in an Age of Uncertainty: The National Security Strategy, Cm 7953, October 2010.

5 HM Government, Securing Britain in an Age of Uncertainty: The Strategic Defence and Security Review, Cm 7948, October 2010.

Part Two

Robustness of assumptions underpinning costs

2.1 The £163 billion Equipment Plan budget for the next 10 years (paragraph 1.1) consists of a core programme of procurement projects, and associated support budgets, and funds held in reserve. The core programme consists of projects identified as priorities by the Department. We have examined:

changes to forecast project costs and budgets (paragraphs 2.2 to 2.8);

the quality of cost forecasts (paragraphs 2.9 to 2.22); and

the potential impact of inaccurate cost forecasts (paragraphs 2.23 to 2.26).

Changes in forecast budgets and costs

Changes in forecast budgets

2.2 Between the 2013 and 2014 Equipment Plans there has been a net reduction of £1.4 billion in the total Equipment Plan budget. However, the amount allocated to the support element of the Equipment Plan has fallen by £6.2 billion compared with the 2013 Equipment Plan. About £4.1 billion of this reduction is from anticipated efficiency savings from the cost of supporting equipment (paragraph 3.10).

2.3 Overall the procurement element of the Equipment Plan has increased in budget by £5.4 billion. This increase is mainly due to:

the roll-forward of the Plan which brings within its scope high 2023-24 expenditure for some projects, most notably the Successor submarine platform; and

cost adjustments to 2 projects, as explained in paragraph 2.6.

2.4 Figure 3 describes the changes in budget totals since 2013 and the 10-year budget profile.

Changes in forecast costs

2.5 In our sample of 17 projects, forecast project costs for the period 2014-15 to 2023-24 have increased on 7 projects and decreased on 10. The net effect has been an increase in procurement costs for our sample of £2.6 billion (Figure 4) across the 10-year period. This represents a 5.9% net increase in forecast project costs since 2013.

2.6 The net increased forecast procurement cost of £2.6 billion is largely due to 2 projects, whose increases were partly offset by cost reductions on other projects:

The Scout specialist vehicle project

The project has been accelerated, leading to an increase of £1.1 billion in its budget over the next 10 years. However, overall costs for Scout specialist vehicle are actually reduced by £613 million over the 30-year period to 2044. The increased funding requirements have been accommodated in the programme without the need for contingency funding.

The Morpheus tactical communications project

While overall costs remain the same for Morpheus, an accounting adjustment has been made to better reflect the contracting strategy. This has moved £2 billion of planned expenditure from support cost budgets into procurement cost budgets.

Changes in forecast costs against project approvals

2.7 We reviewed project performance against approved costs for the 11 projects where the main decision to invest had already been taken (see Appendix Two).6 Although there were in-year cost variations against approved costs on 9 projects during the year, the overall situation was stable. The one large increase resulted from the revised baseline of costs for the Queen Elizabeth Aircraft Carriers (see Major Projects Report 2013). Excluding this project there was a net in-year cost reduction of £397 million (0.7%).

2.8 The other large variation was on a new investment approval for the Lightning joint strike fighter project. This was approved during 2013-14, so is not part of the analysis in the previous paragraph. The Department approved the procurement of the first UK squadron at a budgeted cost of £2.75 billion (within a total budgeted cost of £3.75 billion). The project team are currently forecasting that the cost of the new approval will be £326 million less than this (12% of the approved cost). This is because of accounting adjustments for foreign exchange movements and reductions to the assumed levels of risk and uncertainty. Incremental approvals such as this prevent the Department from committing to unaffordable expenditure, and, it believes, enable it to respond more quickly to changing requirements and to alter its plans to address the needs of the armed forces without having to renegotiate contracts. However, incremental approval can make it more difficult for outside observers to understand the full cost of projects.

Quality of project team forecasting

2.9 All large defence projects have a range of potential costs based on the likelihood of different scenarios and risks. The Department requires project costs in the Equipment Plan to be forecast at the median of the potential cost range; this is referred to as the ‘50th percentile cost’. Each project is as likely to cost less than this estimate as it is to cost more. Some variation is therefore to be expected. Forecasting requires judgement, so costs are not absolute and can be over or understated.

Incorporation of risk and uncertainty into forecast costs

2.10 The total spend for our sample of 17 projects in 2013-14 was £3.7 billion, a net overspend of £61 million (2%). The main reason was the application of extra resources to various programmes to maintain schedules or recover time lost.

Impact of uncertainty around in-year expenditure on forecast costs

2.11 In its report on the 2013 Equipment Plan the Committee of Public Accounts recommended that the Department should improve its data collection to identify the main causes of any under or overspend.7 The Cost Assurance and Analysis Service therefore reviewed the 21 major projects that showed the largest variance in 2012-13 and 2013-14 spend against the 2012 planning round. The net impact of the variances was a large underspend. Figure 5 shows the root causes of underspending.

2.12 Most underspending was the result of decisions to move expenditure backwards or forwards in time relative to the original plans used by the Department to set its budget. This reflected over-optimism by project teams and industry alike. In particular, project teams were uncertain in making and reviewing accounting adjustments. The Cost Assurance and Analysis Service found multiple financial planning adjustments totalling hundreds of millions of pounds. This situation was compounded by a lack of clarity in specialist guidance to project teams and an overly complex budget structure.

2.13 The Department is implementing a ‘forecasting improvement programme’ in the Defence Equipment and Support organisation in 2014-15 with the intention of delivering improved forecast accuracy by project teams, better decision-making through greater transparency, and a better understanding of the implications of over and underspending (including the impact on future years).

Treatment of inflation, foreign exchange and VAT in forecast costs

2.14 Allowances in forecasts for inflation and foreign exchange movements have been falling after recent falls in inflation rates and the strengthening of the pound. In our sample of procurement projects, we found 4 cases where we had concerns about the treatment of inflation. However, the rates in these cases were not consistently too high or too low. In 2 cases in our sample of support projects, the team was using an inflation rate from outdated corporate planning assumptions; they were not regularly reviewing the rate.

2.15 The Cost Assurance and Analysis Service compared changes in cost estimates across 21 projects between 2013 and 2014. It found that project teams had reduced allowances for inflation and foreign exchange movements during the year by £316 million, primarily in 3 of the 21 projects. By comparison the Service reduced its own estimates for those projects by £718 million.

2.16 In August 2014, the Department reviewed the treatment of VAT by project teams. It found that some teams had incorrectly assumed that their project was exempt from VAT, or that VAT paid could be recovered. HM Revenue & Customs have since changed their policy on applying VAT to some projects. The Department is aiming to increase its capability in taxation matters and will focus more closely on this issue during its internal progress reviews.

Incorporation of risk into forecast costs

2.17 We found that good practice in cost modelling and risk is inconsistent across project teams. Weaknesses in estimating costs were also identified by external consultants in their review of support costs on behalf of the Department.

Cost modelling

2.18 Only 9 of the 17 procurement projects examined had generated a range of potential costs in line with good practice. Generating a range of probable costs is standard practice for the Cost Assurance and Analysis Service, and helpful in understanding risk. However, costs that lie above the 50th percentile within a cost model are not built into projects’ budget lines – the elements allocated to risk in costings up to the 50th percentile are, therefore, known as ‘risk inside cost’, and those above the 50th percentile as ‘risk outside cost’. The Department needs to be aware of the likelihood and potential cost of ‘risk outside cost’ when making decisions about the necessary contingency. Only 9 projects could cost risks above 50%. The total impact of these risks would be £2.5 billion if all risks were realised.

2.19 We found a variety of practices and ability to supply evidence regarding support cost forecasts. Until 2013-14 there had been no reliable cost forecast for the Typhoon In Service Support project. The project team has begun work to produce a robust evidence-based model.

Accounting for risk

2.20 All 17 procurement projects we reviewed had a formal process for assessing risks but found it hard to show how quantified risks were built into the costings. Only 3 project teams were applying good practice across all aspects of risk management for their project. The project teams had varied risk analysis skills, leading some to rely on the Cost Assurance and Analysis Service or industry for data and modelling.

2.21 The quality of costing risk is inconsistent between project teams, with some demonstrating good practice while others need improvement. For example, there is no detailed and costed list of risks and opportunities for the Typhoon fighter aircraft support costs (with approved costs of £13.1 billion), 11 years after the aircraft entered service. Instead a general management provision has been included in the forecast cost to cover risk.

2.22 Project teams decide what risks to include in their cost modelling. Typically risks are excluded where they are low probability but high impact, or when the risk is outside the team’s control. It is not unreasonable to exclude some risks from the forecast costs, but as in 2013, we found failures to identify, record and report these risks consistently. Only 2 of our sample of 5 support projects could produce a range of costs that covered uncertainty and risk, and had profiled risk to understand how the risks of different programmes could cause cost pressures in specific years. These 2 projects had quantified risks outside forecast costs to a value of £510 million if all risks were realised. Failure to quantify risk appropriately is a common reason for the Cost Assurance and Analysis Service to challenge costings.8

Potential impact of inaccurate cost forecasts

Cost forecasting in-year

2.23 Figure 6 shows that the Department spent £13.87 billion on equipment in 2013-14, £185 million (1%) more than its original equipment budget. It achieved this by programming £920 million of work at the start of the year in addition to that within the original budget, and added a further £213 million of work during the year when the likelihood of an underspend emerged. The projects in our sample overspent by £60 million (2%) in 2013-14. In 2012-13, we reported that the Department underspent on equipment by £1.15 billion against the total value of its work programme for the year (original equipment budget plus additional work programmed during the year). For 2013-14, the equivalent figure was £948 million. The root causes of this underspending are discussed in Figure 5. Shortcomings in management information and cost forecasting could cause slippage in project delivery or additional costs to recover time lost.

Longer-term impact of under-budgeting for projects

2.24 On some projects the project team and the Cost Assurance and Analysis Service forecast continue to differ significantly over a number of years. Each year the Department’s independent Cost Assurance and Analysis Service reviews the procurement costings that are used to inform the Equipment Plan. In 2014, the Service reported potential under-costing by project teams of £3.2 billion. This is £1.1 billion less than the £4.3 billion identified by the Service in 2013.9 The estimate is a combination of:

project-specific cost estimates for large complex projects (69% of the value of the portfolio); and

application of a cost model, which uses historic trend analysis, to other projects based on historic performance for cost growth and schedule slippage (31% of the value of the portfolio).

Of the £1.1 billion reduction, £895 million (80%) of this has come from a change in the output of the historic trend analysis model.

2.25 Previously, the Department was unable to give us data to undertake a detailed review of equipment support costs. However, by January 2014, the Cost Assurance and Analysis Service had reviewed 28% of the support cost budget (half their level of coverage of the procurement budget). We looked at the variance between the Service’s estimate of the most likely outturn and project teams’ forecasts used in planning assumptions across these projects. This aggregated to an extra £2 billion above the amounts allocated within the Equipment Plan (although the estimates are of varying levels of maturity). The Service expects to have reviewed 50% of support cost forecasts by 2015, and to have reviewed support costs to a similar level to procurement costs by 2016. It does not consider it practical to develop a model to forecast cost movements for the projects not covered by specific estimates. In paragraphs 3.13 to 3.15 we discuss how the contingency provision is intended to mitigate potential overspends.

2.26 Cost growth in projects on the scale estimated by the Cost Assurance and Analysis Service would exceed the Department’s contingency provision, leading to the use of funds set aside for other capability requirements identified by commands.

6 A project is approved in a number of phases, so the costs in this comparison might not cover the same period as the Equipment Plan costs for that project.

7 HC Committee of Public Accounts, Ministry of Defence: Equipment Plan 2013 to 2023 and the Major Projects Report 2013, Fifty-seventh Report of Session 2013-14, HC 1060, May 2014.

8 The Cost Assurance and Analysis Service completed their first analysis of support costs in 2013-14 and continue to mature this work; their views on support costs may change as they develop greater levels of understanding about the drivers of support cost.

9 We reported £4.4 billion in our 2013 report for the period 2013 to 2023. The 2013 estimate for the period 2014 to 2024 is £4.3 billion which provides a like for like comparison to the 2014 estimate.

Part Three

Assumptions underpinning funding

3.1 The Department funds Equipment Plan expenditure with the budget allocated by HM Treasury through the Spending Review process. Funding for the Equipment Plan is not protected by HM Treasury; the Department has to allocate its budget for equipment costs internally, ensuring that there is also enough budget to meet non-equipment costs, such as the management of the Defence Estate and costs of Armed Forces personnel. The Department is planning to spend £14.5 billion on equipment procurement and support in 2014-15. This is 44% of the Department’s core budget in 2014-15 (Figure 7).

3.2 Whether the Department can deliver the core Equipment Plan depends on a number of factors, including:

the costs of the major programmes in the Equipment Plan remaining stable;

the planned procurement and support savings initiatives providing the required level of cost reductions;

efficiencies in the non-Equipment Plan spend being realised; and

the contingency provision being enough to absorb any cost growth, so that the unallocated budget remains available for capability over and above the core programme.

3.3 We have examined the Department’s assumptions that:

it has enough funding to procure and support the core equipment it needs (paragraphs 3.4 to 3.15);

it has enough funding to meet the Future Force 202010 capability objectives that extend beyond delivering the core Equipment Plan (paragraphs 3.16 to 3.18).

Sufficiency of Departmental funding

Proportion of funding allocated to the Equipment Plan

3.4 The proportion of the Department’s budget allocated to the Equipment Plan increases from 40% in 2013-14 to 44% in 2014-15 (Figure 7). The proportion of the Department’s total budget that is available for the Equipment Plan depends on the settlement that will be agreed with HM Treasury in the next Spending Review. If the Department’s planning assumptions are correct the proportion allocated to the Equipment Plan remains around, or just below, 44%. However, if the funding is lower than planned the proportion of funding that is allocated to the Equipment Plan may increase to 47% of total budget by 2019-20. Whether the Department can allocate a greater proportion of its budget to the Equipment Plan depends on its achieving plans to reduce manpower and its Defence Estate. The Department is confident that non-Equipment Plan savings are being met, but we have not seen evidence to confirm this as part of this review.

Level of Departmental funding over the 10-year Equipment Plan

3.5 In July 2011, the Department agreed a settlement with HM Treasury for its forward Equipment Plan budget from 2014-15 to 2020-21. The settlement is for a fixed planning profile of funding for the Equipment Plan for each year in the period covered. It was calculated based on a 1% real funding increase above inflation. The Department’s Equipment Plan budget is currently significantly higher than the amount allocated to it by HM Treasury for equipment procurement. There is no restriction preventing the Department increasing the Equipment Plan budget in this way.

3.6 For the years beyond the current 10-year Equipment Plan the Department has assumed that it will continue to receive an increase in the budget of 1% above inflation, although this has not been formally agreed with HM Treasury. For the non-Equipment Plan element of the budget the Department assumes that funding will match inflation from 2016-17, with no further funding reductions or increases.

3.7 In our review of the Equipment Plan 2013 to 202311 we reported that there is a potential difference in available funding for equipment of £15 billion over the life of the Equipment Plan, depending on what starting point is used in determining the Department’s settlement in the next Spending Review. The Department has since confirmed that they are planning on the basis that the funding settlement in the next Spending Review will use the Department’s position following the Spending Round 201312 funding reductions as a starting point. This is a reasonable assumption for planning purposes. We are not able to comment further on the reasonableness of the full range of assumptions used as the Department has not provided us with the details of the level of total funding they expect to receive from 2015-16.

Funding changes between 2013 and 2014

3.8 The Department’s ability to fund non-equipment costs is also dependent on it controlling planned growth in the Equipment Plan. There is a net reduction between the 2013 to 2023 and 2014 to 2024 Plans. The planned budget of £163 billion for the period 2014 to 2024 represents a drop of £1.4 billion against the final budget for 2013 to 2023. However, across the 9 years that the 2 plans have in common (2014 to 2023) there is a reduction of £5.8 billion (see Figure 8). Most of this is due to the removal of £4.1 billion from the support budget to be met from an ongoing review to identify efficiencies in the support budget.

3.9 The Department has also brought forward expenditure to fund additions to the core programme. However, it has used the savings described earlier to fund the resulting cost increases rather than drawing on contingency or, for the most part, unallocated funding. The effect of the additional funding against the cost reductions is shown in Figure 9.

Management of costs and risks at portfolio level

3.10 The reduction in the Equipment Plan budget depends on initiatives that the Department expects will produce the required efficiency savings over the 10-year period. The largest sums relate to support cost efficiencies, with £4.1 billion of savings to be achieved by the commands, working with the support of external contractors.13

3.11 The Department engaged consultants to carry out a review of projects to identify savings from the support budget over 10 years. At the end of each project review the relevant project team agrees to an efficiency savings implementation plan. This plan is then incorporated into project costings and put to commands for their approval as budget holders. They will also assist in transferring skills to staff within the Department to create a sustainable approach to identifying and securing efficiencies. They have reviewed 11 major support projects to date, constituting nearly 40% of the value of the equipment support programme. The project teams provisionally identified potential savings of £2.9 billion over 10 years. Figure 10 shows the areas in which identified savings and greater efficiencies were identified.

3.12 In addition to the potential savings identified in the support costs, there are a number of cost reductions initiatives within the Equipment Procurement Plan. If these do not produce the forecast level of savings, there could be significant cost growth and potential impacts on capability. The most significant efficiency programmes with the Plan are as follows:

We reported on the Submarine Enterprise Performance Programme (savings worth £1.05 billion) in the Equipment Plan 2013 to 2023. As at 31 March 2014, only around £200 million of the savings had been realised.

There is an industry improvement project known as PULSAR, which is aimed at improving the efficiency of the contractor’s submarine programmes. A key objective of this project is to ensure that the Astute programme is completed to its planned schedule. At the time of our review, the project did not have an approved business case; nor did it have an agreed baseline with industry against which improvement could be measured.

The Complex Weapons procurement approach estimated financial benefits of £1.2 billion over 10 years from 2010. We reviewed Complex Weapons in detail as part of the Major Projects Report 2013. As at June 2014, the Department had identified £196 million of savings towards this target.

Sufficiency of contingency

3.13 The Equipment Plan contingency funding of £4.6 billion is available from 2017-18, and increases in value over the rest of the 10-year plan to reflect the increased risk of forecasting costs further into the future. The contingency funding is intended to cover the risk of:

cost growth;

failures to achieve savings targets;

risks maturing;

unexpected events that have financial impacts; and

over-optimism in project teams’ costings.

3.14 In paragraphs 2.24 to 2.25 we explained that the Cost Assurance and Analysis Service has stated that project teams are underestimating their cost forecasts. Moreover, the project budgets included in the Plan by the Department may in some cases be lower again than these estimates. External consultants have identified several support projects where the costs in the Plan do not reflect teams’ knowledge. When this is the case, the position is referred to as a ‘cost challenge’ and the project team is tasked with bringing the forecast to within the available budget.

3.15 In January 2014, the Cost Assurance and Analysis Service estimated that procurement budgets within the Equipment Plan understated realistic forecasts of outturn costs by £4.7 billion. In April 2014, the Department adjusted its budget allocations, adding £2.4 billion to the 2014 Equipment Procurement Plan. The Department’s contingency allowance covers this, but there is no estimate of the extent to which support budgets might be underestimated (if support budgets were also underestimated it would be in line with the Service’s findings on project team forecasts – see paragraph 2.25). It therefore risks being unable to provide adequate cover for future cost growth.

Achievability of strategic objectives

3.16 The Department recognises that Future Force 2020 cannot be realised by improving equipment procurement alone. It will need to make other changes if it is to achieve its objectives within budget. These include:

making efficiency savings across the Department;

using unallocated expenditure appropriately;

making a success of its new operating model; and

making changes to the way in which the Armed Forces conduct training and operations.

3.17 During the 10 years of the Equipment Plan 2014 to 2024, the Department has unallocated procurement expenditure – ‘headroom’ – of £8 billion. Most of this will be available towards the end of the planning period. The Department intends to use this money to fund extra projects beyond the current core programme according to their military priority (and assuming they are affordable), so that it can reach the full equipment capability needed to meet its longer-term objectives. The individual commands are being given the responsibility for allocating this expenditure as part of a wider Transformation Programme, since the Department believes that they are in the best position to judge how to use the unallocated funding most effectively.14

3.18 Land and Navy commands have been the first commands to exercise this new responsibility, drawing down £392 million to fund 2 projects in future years. Land command is the most likely command to experience capability gaps unless it can procure equipment beyond the core programme.15 We reported in our 2013 report that over 50% of the unallocated budget has been provisionally apportioned to Land command, and it has distributed 10-year funding plans to its project teams on the basis that £2.4 billion of the headroom will be available to them when necessary.

10 Future Force 2020 is the Government’s intended shape of the Armed Forces from 2020.

11 Comptroller and Auditor General, Ministry of Defence, Equipment Plan 2013 to 2023, Session 2013-14, HC 816,
National Audit Office, February 2014.

12 HM Treasury, Spending Review 2013, Cm 8639, June 2013.

13 Consisting of a £3.5 billion reduction in funds allocated by HM Treasury and an additional £600 million Departmental challenge to commands.

14 The National Audit Office, Briefing for the Committee of Public Accounts: Reforming the Ministry of Defence, February 2012.

15 Comptroller and Auditor General, Ministry of Defence: Equipment Plan 2013 to 2023, paragraph 57, Session 2013-14, HC 816, National Audit Office, February 2014.

Part Four

Disclosure

4.1 The Department’s annual Statement on the Affordability of the Equipment Plan should:

aid transparency;

show whether the Equipment Plan is affordable and achievable; and

provide the defence industry with more information for planning.

4.2 Using International Assurance Standards (see Appendix One), we examined whether the statement contains adequate and sufficient disclosures for users of the Equipment Plan to fully understand:

the key assumptions that have been used to generate the Equipment Plan costs and the sensitivity of the costs to changes in those assumptions; and

the key assumptions that the Department has made about the level of available future funding, and the sensitivity of affordability of the Equipment Plan to changes in those assumptions.

Disclosure regarding cost assumptions

4.3 The Statement is similar in format and content to those of earlier years. It contains a breakdown of the Equipment Plan budget into its component parts. This enables the reader of the Statement to identify:

the costs related to procurement and support;

the unallocated budget; and

the contingency provision detailed on a year-by-year basis for the reported 10-year period.

There is sufficient discussion for the reader to understand the nature and rationale of the different components of the Equipment Plan, including the contingency provision and unallocated budget.

4.4 We are pleased to note that the Statement has further disclosures that address some of the recommendations in our 2013 report:

The Statement now explains how project teams generate forecast costs. It also refers to the findings of the Cost Assurance and Analysis Service.

The Statement also gives information on the key savings initiatives.

4.5 The Statement’s disclosures have improved but there are still areas where further detail is required. Readers need to fully understand the fundamental assumptions that underpin the Equipment Plan, and the risks and sensitivities to implementing it within budget. We would expect disclosures to describe:

the drivers for the changes including risks, if any, to capability due to the planned budget reduction;

the approach to inflation and foreign exchange assumptions and the sensitivity to these assumptions;

consideration of the range of possible values the total Equipment Plan could cost;

the total value of risk outside costing and the impact on affordability should these risks materialise;

information on how the savings targets will be measured, what the key milestones are, and when the Department will report on whether savings targets have been met; and

the impact that cost increases in the largest programmes would have on affordability, so that the reader of the Statement understands how sensitive the overall position is to movements in the projects in the Equipment Plan.

Disclosure regarding funding assumptions

4.6 Our observations are similar to those in our 2013 report. The Statement adequately discloses that funding available to the Equipment Plan is underpinned by an agreement with HM Treasury which provides for a minimum level of funding predicated on a 1% increase above inflation until 2020-21. It is also clear about the method and rationale for allocating funding to a core programme while retaining an £8 billion unallocated budget. However, for the user to fully understand the effect that changes in the funding assumptions could have on affordability, the Statement should also contain the following:

Information on the Department’s assumed total funding within which the Equipment Plan budget will have to be met, and the sensitivity of the Plan’s affordability should these change.

Information on the need to meet cost reduction targets in non-equipment areas of the Department’s budget to ensure that the planned level of funding is available for the Equipment Plan.

Appendix One

Our audit approach

1 This year for the first time we are combining what have previously been 2 separate outputs, the Major Projects Report and our review of the affordability of the Equipment Plan. This reflects the close relationship between the 2 pieces of work:

The sample of projects for our Major Projects Report is also used for our review of the Equipment Plan.16

The Major Projects Report looks at the impact of changes to time, cost and performance measures. It provides some evidence of the stability of the programme on which the forward assumptions in the Equipment Plan are based. Our review of the Equipment Plan provides further detail on the accuracy and risks to the project cost and time forecasts reported in the Major Projects Report.

2 Our work is based on a sample of 17 major military equipment projects.17 These include the 11 largest where the Department has taken the decision to to proceed to the demonstration and manufacture stage. This year we have in addition looked at 5 of the largest support programmes, shown in Figure 13 of Appendix Two.

Affordability of the Equipment Plan

3 As previously we built a model to test the Department’s assertions within its assessment of the cost of the Equipment Plan and the funding available. The model breaks down those assertions into a set of hypotheses, as set out in Figure 11. We used the following methods to test these hypotheses:

We reviewed alternative cost estimates generated by the Department’s internal Cost Assurance and Analysis Service. We worked with their staff to understand the methods and scope of their work. When there were significant differences between the Service’s and the project teams’ estimates we evaluated the risk to the affordability assertion.

We reviewed the cost models and cost-estimating techniques used in generating cost forecasts; risk management; and how uncertainty and risk are built into costings. We also matched actual spend to contracted amounts.

We reviewed the application of central government guidance on how to treat inflation and foreign exchange.

We reviewed historical data on actual costs against planned spending. This enabled us to assess the Department’s ability to accurately forecast costs on a yearly basis.

We assessed the Department’s process for aggregating project costs into the Equipment Plan.

Project cost, time and performance

4 This is the thirty-first year in which we have reported to Parliament on in-year changes to the cost, time and technical performance of major projects. We publish the Department’s data for the 11 projects; these data cover cost, time and performance against the original plans when the decision to proceed to the demonstration and manufacture stage was made. We validate but do not audit these data. We perform analysis to report on overall trends and in-year performance. We also validate and publish more limited data on the projects where the main investment decision is yet to be taken (including the Cipher project, which was brought to a conclusion in 2013-14, and so is not part of our further analyses conducted on the remaining 6 projects in our procurement sample).

5 For the time, cost and performance of major projects we measured the largest projects’ forecasts against original approvals:

The project teams in Defence Equipment and Support put together the project summary sheets that are published in Volume II of this report. We validated the data back to supporting evidence such as planning documents, contracts, project plans, contractor reports, and assessments of performance by the Director of Capability and front-line commands.

Using the qualitative and quantitative data collected, we considered whether the Department is anticipating that the project will meet the budget, time and performance expected when the main investment decision was made.

Assessing whether Affordability Statement disclosures are adequate

6 To assess whether the disclosures in the Department’s Affordability Statement are adequate and sufficient, we used as a framework the ‘International Standard on Assurance Engagements 3400: The Examination of Prospective Financial Information’ (the Standard).18 The relevant elements extracted from the Standard that are applicable to this engagement are as follows:

The presentation of prospective financial information is informative and not misleading.

The assumptions are adequately disclosed in the notes to the prospective financial information. It needs to be clear whether assumptions represent management’s best estimates or are hypothetical and, when assumptions are made in areas that are material and are subject to a high degree of uncertainty, this uncertainty and the resulting sensitivity of results needs to be adequately disclosed.

The date as of which the prospective financial information was prepared is disclosed. Management needs to confirm that the assumptions are appropriate as of this date, even though the underpinning information may have been accumulated over a period of time.

The basis of establishing points in a range is clearly indicated and the range is not selected in a biased or misleading manner when results shown in the prospective financial information are expressed in terms of a range.

16 The review of the Equipment Plan also includes an examination of the support costs of a small additional sample.

17 Originally the sample size was 18 but the Cipher project was concluded during 2013-14. A Project Summary Sheet for Cipher has been included for transparency, but the project data is not included in our analyses as it is no longer extant.

18 Available at: www.ifac.org/sites/default/files/downloads/b013-2010-iaasb-handbook-isae-3400.pdf

Appendix Two

Major projects: cost, time and performance in 2013-14

Scope of the review

1 Each year the Ministry of Defence (the Department) presents to Parliament a Major Projects Report that provides data on the cost, time and performance of the largest defence projects where the decision to proceed to the demonstration and manufacture stage has been taken (11 of the projects in our procurement sample).19 Full details of the projects are shown in Figure 12. The Department’s report also contains less detailed information on the largest projects where the main investment decision has not yet been taken (see Figure 13). The NAO validates, but does not fully audit, the data. This report presents our analysis and key conclusions. Short summaries of each project can be found at Appendix Four and the full project summary sheets are contained in Volume II of this report. As explained in paragraph 1.6, we have used the same samples in this review as our work on the Equipment Plan. An explanation of our approach is in Appendix One.

Cost

2 We examined the cost movements for the elements of the 11 projects in our sample where the Department has decided to proceed to the main demonstration and manufacture stages of the project (see paragraphs 3 and 4). As well as examining the cost movements of the entire sample, to allow a like for like comparison to the previous year we also examined the cost movements of those projects where the decision to proceed was taken prior to 2013-14 (see paragraphs 5 and 6).

3 Across the 11 projects we examined, we found there has been relative stability in the cost forecasts during 2013-14. Overall, we found a net cost reduction of £397 million during 2013-14 (0.7% of the current forecast cost to completion of £59.2 billion),20 excluding the cost movement on the Queen Elizabeth Carriers.21

4 The overall in-year cost variation of those elements of projects that were approved to proceed to demonstration and manufacture during 2013-14, which total £3.7 billion, was a net reduction of £338 million (0.6% of total forecast costs for the sample). The largest single in-year variation relates to a new approval to proceed to manufacture within the Lightning joint strike fighter project. In January 2014, HM Treasury approved the procurement of the first UK squadron at an additional budgeted cost of £2.75 billion. However, the project team are now forecasting that the cost will actually be £2.42 billion, a £326 million (12%) reduction against the budgeted cost. This is partly due to an accounting adjustment which has removed a £204 million provision for foreign exchange rate movements in future years from the forecast, and reductions to the assumed level of risk and uncertainty. Exchange rate adjustments may then be added back into the forecast as appropriate on an annual basis, if the exchange rate moves in a way that is unfavourable to the project. The remaining £122 million reduction in forecast is due to actual foreign exchange movements during 2013-14, and a reduction in the assumed levels of risk and uncertainty. The overall costs of all projects is £5.7 billion (10.6%) higher than originally forecast.

5 Excluding those projects and elements of projects where there has been a new approval since April 2013 allows us to compare cost movements on a like for like basis with last year’s analysis. Across these projects there was a net reduction of £59 million (0.1%) in the forecast costs, indicating stability in these projects. This excludes the Queen Elizabeth Carrier project which we reported on in the Major Projects Report 2013.22 The total forecast costs for this subset of projects is now £55.5 billion, an increase of £6.1 billion (12%) since the main investment decision was taken.

6 Within the net cost reduction of £59 million there has been a number of reductions and increases on individual projects. The 2 projects with the most significant variances by proportion of the project cost were:

A 6% (£34 million) reduction in the cost of the Military Afloat Reach and Sustainability tankers to reflect the retirement of project risks.

A 5% (£125 million) increase in the forecast cost of activities for elements of the Lightning joint strike fighter project where the investment decision pre-dated 2013-14. This was mainly due to accounting adjustments to allocate planned costs from later production phases into the ‘system development and demonstration’ phase to reflect the fact that this phase will not conclude as expected in 2016 and has been extended to 2019. However, when all project approvals for the Lightning joint strike fighter are taken into account, overall project cost forecasts have decreased by £201 million.

The largest reduction in costs, by value, was a 1% (£109 million) decrease on the Typhoon programme, after a downward assessment of the production cost of the third tranche of aircraft.

Causes of cost variations

7 In 2013, we identified changes to inflation assumptions as being the main cause of variations within the sample. This year there were a wider variety of causes; mainly exchange rates, budgetary factors and accounting adjustments and redefinitions.

8 As described in paragraph 4 the Lightning joint strike fighter aircraft project had a £2.75 billion change to its approved cost in 2013-14 following approval to move to the next production stage. This is an example of a large and complex project where the Department’s approach is to break a large project into smaller stages and approve them in increments rather than in a single block. The Lightning project has so far had 3 investment approvals during the demonstration and manufacture phase and more will be necessary to meet the requirement. While this allows the Department to be more responsive to changing requirements, there are risks (for example suppliers’ loss of certainty about future orders). It also can reduce transparency within the Major Projects Report data about the full cost of the programme, and the extent to which capability requirements are being met for the sums approved.

9 There are several projects in our sample that have large increases in expenditure in their assessment phase because this phase now includes activities originally intended for later in the project. Later investment approvals should reflect the consequences of this advance of expenditure.

10 In 2013-14, the Cost Assurance and Analysis Service have continued to carry out their own estimates of the likely cost of projects within our sample (including projects yet to achieve approval to proceed to the demonstration and manufacture stage). The comparison of the project teams’ estimates included in the Equipment Plan forecasts against the Service’s estimates of the most realistic outturn yields an overall net cost of £1.2 billion (3.2%) higher than project team forecasts across the period of the Equipment Plan. Most of this is accounted for by 2 projects.

Time

11 The total additional delay in 2013-14 to the operational delivery of 10 projects in our sample with in-service dates is 14 months. This excludes additional in-year delay for the Queen Elizabeth Class Aircraft Carriers which was reported in The Major Projects Report 2013.23 Excluding this project the additional delays were:

Eight months for the project to upgrade the Warrior armoured vehicle, due to granting the contractor more time to develop the design. This delay is against the assumptions used for the Equipment Plan; however, it does not yet threaten the project’s approved in-service date which is based on different assumptions.

Six months for the submarine core production facility, due to delays in regulatory approval and a change in commissioning strategy. The project team reports that this delay will not have an impact on the delivery of the cores to meet the operational programme.

12 The total forecast delay to the 10 projects against the approvals used for planning purposes is 315 months.

Performance

13 When the Department takes the main investment decision it approves a number of key performance measures for each project. These provide an indicator of whether the equipment is providing the intended military capability. Across the 11 projects, the Department has set 182 key performance measures and expects to achieve all but one of these, although the Department has identified risks to achieving 4 others. Each project also reports against 8 defence lines of development. These measure the other elements of capability, such as trained personnel and logistical support, which the Department needs to develop and deliver at the right time to ensure that it can best use the equipment. It expects to deliver all of the defence lines of development on time, with risks attached to 20% of the lines.

19 We count the Complex Weapons portfolio as a single project for these purposes.

20 This is the 50th percentile cost, derived from cost modelling, which gives a profile of possible costs for a project. The 50th percentile is the midpoint of the range of costs. Each project is as likely to cost less than this estimate as it is to cost more. It is used by the Department for planning purposes.

21 2013-14 cost increases for this project were reported in the 2013 Major Projects Report.

22 Comptroller and Auditor General, The Major Projects Report 2013, Session 2013-14, HC 817, National Audit Office, February 2014.

23 Comptroller and Auditor General, The Major Projects Report 2013, Session 2013-14, HC 817, National Audit Office, February 2014.

Appendix Three

Performance indicators

These are the measures against which the Department must improve its performance in order to show that it has addressed the key risks to the affordability of the Equipment Plan.

Appendix Four

Executive project summary sheets

Post-Main-Gate projects

A400M

Astute Class Submarines

Complex Weapons Pipeline

Core Production Capability

Future Strategic Tanker Aircraft

Lightning II

Military Afloat Reach and Sustainability

Queen Elizabeth Class Aircraft Carriers

Scout Specialist Vehicles

Typhoon

Warrior Capability Sustainment Programme

Assessment phase projects

Cipher

Crowsnest

Marshall

Morpheus

Successor

Type 26 Global Combat Ship

Concept phase projects

Attack Helicopter Capability Sustainment Programme

Post-Main-Gate projects

Assessment phase projects

Concept phase projects

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