Defence-industry policy searching for tinkers, tailors and candle-stick makers

There is an interesting element to the Deloitte report reviewing the approach to Australian Industry Participation (AIP) in regard to the rollout of Phase 2 of Project LAND 400. When the government announced in April 2016 that it was deferring for three months the down-select of Phase 2 tenderers, the decision was greeted with some scepticism. Surely one of the bidders had run into difficulty meeting RFT time schedules/performance criteria, and therefore had pushed Defence for additional consideration in order to finish off their proposal? Perhaps not so this time around.

As we keep being told by new Defence Industry Minister Pyne, there is a very real difference between the environment for the encouragement of Australian industry participation in new military capability acquisition projects now, than existed prior to publication of the 2016 Defence White Paper and the Defence Industry Policy Statement (DIPS) that accompanied it.

When Phase 2 AIP arrangements were drawn up, project officers religiously followed the rules previously outlined by government. Hence, the Deloitte Report found their actions to be not inconsistent with the intent of the new DIPS. But did the AIP provisions in Phase 2 take maximum advantage of the new measures contained in the 2016 DIPS? Apparently not.

So having missed the opportunity to fully leverage the bounty of the new DIPS in the original Phase 2, the AIP torch is now being passed to the next stage in the LAND 400 evaluation – the Risk Mitigation Activity (RMA) – in order to open up the landscape for local industry participation in the project, as well as ensure that the fullest advantage is taken of the measures contained in the new DIPS and accompanying classification of Defence Industry as a Fundamental Input to Capability (FIC).

The most significant aspect of new AIP arrangements to be applied to the LAND 400/2 RMA are new instructions on what constitutes military-off-the-shelf (MOTS) and MOTS Plus, as originally defined in the RFT and draft RMA. The Deloitte report says that during the industry workshops conducted as part of its review, project staff had provided clearer guidance on the interpretation of both terms, but perhaps the message regarding what they said had not made the mass distribution list.

The nub of the change in interpretation relates to advice to industry that the definition of MOTS does not preclude the substitution of Australian-supplied componentry in the vehicle, as long as it meets the same performance standards. Defence now recognises that there is a rapidly changing and developing MOTS baseline worldwide in military equipment, especially combat vehicles where solutions evolve at pace in response to burgeoning threats.

This also explains the inclusion of a MOTS Plus option, in order to allow tender responses which included the ‘current year model’ some flexibility, as well as provide a window into what was expected to be in service by the time of the final source selection.

Accordingly, it did not make any sense that local manufacturers not found to be competitive on components for which foreign production lines were already established, were then locked out from opportunities to supply components when vehicle inclusion lists changed, especially as Defence had included in the RFT a requirement for a well-developed update and growth path for the vehicle over its anticipated life.

Deloitte says the focus on a MOTS-based solution did not, therefore, preclude the substitution of elements or componentry which also met or exceeded the required performance standards without any adverse warranty implications. This was especially so as there appeared to be broad consensus that there are opportunities for competitive Australian industries to contribute to the tenderers’ supply chains and to participate in the upgrade/growth path.

Utilising the new toolset provided in the 2016 DIPS, Defence is now proposing to work actively with the shortlisted tenderers (BAE Systems and Rheinmetall) to investigate opportunities for the replacement of offshore suppliers in each prime’s supply chain with local suppliers, and for participation in the growth path and through-life upgrade of the LAND 400 capability. This effort is to be part of a broader LAND 400 push to ensure and facilitate engagement between the short-listed tenderers and Australian industry.

Again, the nub of the work to proceed during the RMA involves the development of costed options for different levels of Australian industry participation in Phase 2 delivery and sustainment. The basic parameters for the construction of tender responses would therefore be:

a) A best price option for acquisition, regardless of the location of manufacture and assembly, with the capability supported and sustained in Australia;

b) an option, similar to the best acquisition price option, but which includes the use of Australian components in place of overseas sourced parts, which must meet the required performance standards, or other Australian contributions to the fielding of the integrated vehicle system;

c) an option that is an assembled in Australia option with Australian components, with the capability supported in Australia; and

d) an option for a higher level of Australian industry engagement in the manufacture and through-life growth path of the vehicle, if the extensive industry engagement activities proposed to be undertaken during the RMA demonstrate that this is feasible with a low or minimal cost premium.

This of course, will all work as long as Defence has sufficient intellectual property (IP) rights over key elements of the vehicle specification process in order to be able to maximise Australian industry participation in the through-life support of the capability. Design specifications that mandate the use of particular components for no other reason than to direct the business to source country suppliers have long been the bane of efforts to encourage greater local industry participation.

Those with long memories will recall that New Zealand-based suppliers in the ANZAC frigate project were once barred from supplying gangways to the ships – not because they could not meet the functional performance specification – but because they could not match the pattern stamped on the subject gangways. Of course, the pattern was the registered design of a foreign supplier.

The idea of opening up the interpretation of MOTS and MOTS Plus to component substitution also gets Defence off the sticky hook of having to mandate specific quantitative levels of Australian industry content. For however optimistic you feel about the new DIPS policy and the recognition of industry as a FIC, there is no way the Turnbull government is going to let such concessions evolve into a runaway game on major project costs and schedule.

Deloitte’s report takes this issue on the chin by describing the mandating of specific quantitative levels of Australian industry content as having represented in the past, “an unreliable and ineffective basis for ensuring Australian industry participation”. Productivity Commission estimates of the monumental Effective Rate of Assistance that will be afforded to the local manufacture of Future Submarines from the mandated inclusion of Australian steel also provide sober reading on this point.

The landscape for local industry on LAND 400 is therefore much clearer. Provision for the broader interpretation of MOTS and MOTS Plus has been provided in terms of new guidance on the opportunities for component substitution across the manufacturing and through-life sustainment/upgrade phases. The mandating of specific quantitative levels of local content has being rejected on the basis of a reasonable expectation that it is in both tenderers’ interests to bend with the winds of recent changes in defence industry policy and maximise their efforts.

Deloitte puts it another way, saying that in the first instance, “decisions on Australian industry participation by the preferred tenderer would be made on a commercial, value-for-money basis, and therefore, local industry would need to be cost-competitive. Wherever local industry was able to demonstrate that it had a cost-competitive, effective contribution to the Phase 2 capability, Defence would be encouraging, and expecting, the shortlisted tenderers to include it in their final offerings.”

It is now proposed that Defence will work with shortlisted tenderers during the RMA to develop costed options for different levels of Australian industry participation in Phase 2 capability delivery and sustainment. The approach would allow government to make informed decisions on its preferred combination of overseas and local supply. As such, the costed options might indicatively include: a ‘best priced’ option regardless of sourcing; an option using increased Australian supply with minimal cost impact; and an option for vehicle assembly in Australia. In all options, the vehicle capability would be supported in Australia.

There are some further twists. In the above scenarios, Defence would also ensure that any cost-capability trade-offs required with Phase 2 (in order to remain within the available funding provision) would take account of AIP.

Further, Defence will investigate what flexibility exists to treat vehicle components as ‘consumables’, rather than capital, and the implications this change would have for acquisition and support strategies and Australian industry. Phase 4 of the project may also be brought forward from its currently planned mid‑2020s start to ensure early consideration was given to the overall concepts and architecture for LAND 400 simulation.

Standing back from all of the above, one has to be genuinely impressed at the energy with which Defence is now taking the guidance provided by the 2016 Defence White Paper and DIPS to pro-actively work towards satisfying Turnbull government policy that new military capability acquisitions moving forward will be founded upon the creation of an innovative and robust local defence industry. The pity is that all of this effort is being first applied to an acquisition program of not much more than 500 vehicles.

There is an inconvenient truth in regard to proposals to develop Australian defence-industry capacity that the low production volumes typically required by the small Australian defence market often results in a cost premium to the Commonwealth. If promises for a return to Defence funding at two per cent of GDP are realised, a larger domestic market and (through exports) international market could in fact see increased volumes for Australian industry, thereby reducing unit costs and improving Australian competitiveness.

Let’s hope there is also some good news coming soon in attempts to break down the silos between individual elements of the bureaucracy, and therefore bring the Department of Industry, Innovation and Science and the Department of Foreign Affairs and Trade closer together in sponsoring the development of a new and coordinated marketing strategy to promote Australian defence industry capability and products, as well as champion Australian defence industry exports.