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When the Australian National Audit Office’s audit report on the Air Warfare Destroyer program ^[2] was released last week, I was told by a veteran journo that it was a bit of a disappointment to his colleagues. They’d apparently been hoping for a story about a Defence managed fiasco that’d make for screaming headlines along the lines of ‘billions wasted says government watchdog’.

That’s an unfortunate reflection on the state of news reporting these days, because the ANAO report is a very important one, and it has implications far beyond the AWD program. It fills out much of the detail hinted at last year ^[3] in ’round one’. And I’d have thought there are enough titbits in there to make for at least a moderately unhappy story if that’s what required to sell papers (or, increasingly, to draw clicks). But it’s also to my eye the auditor’s best Defence project effort to date, so let me at least put my vote of thanks on the record for an important piece of work.

This report is especially significant because there’s bipartisan support in Australia for continuing naval shipbuilding in country. So despite the shortcomings in the AWD build, more such projects are likely to follow—with costs to taxpayers running into tens of billions of dollars. It’s pretty important to understand what’s happened in this case.

I’d recommend reading at least the summary of the report, but I’ll provide some comments on what I think are the most salient points. Let’s start with the headline issue of cost overruns: the alliance building the vessels is reporting an estimated final cost of some $302 million, or 6.8% above the target cost estimate. But given that the overrun in the 2012–13 financial year was $106.4 million as a result of increased labour, materials and subcontract costs, largely for the relatively straightforward industrial work of module construction, and that the difficult system integration parts are still to come, it could easily get worse than that. The ANAO says as much: ‘the current estimated cost [overrun] of $302 million … should be treated with caution; the cost increase is likely to be significantly greater. … the program is approaching the complex stage of systems integration when, historically, cost and schedule risks tend to rise’.

So by the time the program’s finished, we’re going to end up paying an even larger than expected premium for local construction of these vessels. The report tells us that the 2007 Treasury estimate of the premium was ‘around $1 billion’. My estimate was $1.5 billion ^[4] (PDF), which probably won’t be far off the mark. We also learn that the ‘effective rate of assistance’—a measure of economic distortion due to the program—was estimated at 30%, a figure well above the level for other subsidised industries.

Those figures are sobering. Naval shipbuilding is an enterprise that’s consuming taxpayer’s resources that are therefore not available for other government programs. And there’s no shortage of lobby groups making the case for expanding it, arguing that it’s the stop-start nature of the business that has caused the problems seen here. Indeed, the ANAO includes some comments along those lines from two of the shipbuilders (whose performance fell short of what was expected when the project was approved):

… companies that have participated in the AWD Program, our company included, have faced a significant challenge from the need to re-establish capability, capacity and experience after the gap in naval shipbuilding that preceded the start of AWD construction.

And:

… the costs of ramping back up to a competitive shipyard to maintain the indigenous shipbuilding capability have not been fully appreciated in terms of the magnitude of the investment required in facilities, recruitment, training and retention of the workforce to reach competitive productivity; once established, the shipbuilding capability will once again dilute and disappear if not utilised in an ongoing shipbuilding program out across the Defence portfolio.

As I said above, there’s bipartisan support to respond positively to these entreaties. So the policy question now becomes ‘how best to ensure that the local naval shipbuilding industry performs as well as it can’? The first thing to do is to try to work out how much of the underperformance of the AWD program is due to genuinely unavoidable learning issues in an industry that hadn’t built a warship in well over a decade, and how much is due to factors more amenable to best practice management.

There’s plenty of evidence in this report of start-up and inexperience woes, which seem to have taken pretty much everyone by surprise, despite $262 million being spent on due diligence activities before contract signature. And some of the problems should’ve been predictable. Looking over the report, devotees of Augustine’s and Gumley’s Laws will recognise some old friends. In paragraph 26, for example, we find:

… additional modifications primarily to accommodate the Australianised Combat System, which comprises an upgraded Aegis Weapon System and additional Australian elements to meet specific capability requirements. The selection of largely existing platform and combat system designs formed the basis of the DMO’s technical risk reduction strategy for the Program, and was considered at the time to provide a high level of comfort.

The ‘specific capability requirements’ might well be Augustine’s final 10% of capability ^[5], which we know leads to 1/3 of the cost and 2/3 of the risk. And Gumley’s laws remind us that combining off-the-shelf systems isn’t off-the-shelf. (MOTS + MOTS ≠ MOTS ^[6])

But that was then and this is now. And those errors, while regrettable, are now behind us. Hopefully we’ll learn from the experience and not repeat the beginner’s mistakes that have plagued this program. Next week I’ll come back to the report and tease out what it might teach us for future naval shipbuilding programs. There are some powerful lessons here—especially for the future submarine.

Andrew Davies is senior analyst for defence capability at ASPI and executive editor of The Strategist. Image courtesy of Department of Defence ^[7].