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The Air Warfare Destroyer project – how effective is the alliance model?

Posted By on September 16, 2013 @ 13:20

Hobart class DDG (artist's impression) [1]Of all the issues facing the new defence minister, the replacement of the Collins class submarines stands out in terms of scale, complexity and difficulty. A critical aspect of this multi-billion dollar program will be the commercial arrangements under which the boats are built. The challenge is to design a commercial framework that brings together local industry and foreign suppliers while protecting taxpayers’ interests and assuring that the Navy gets what it needs.

Fortunately, we have an experiment already underway in one of the possible options; the alliance contract being used to deliver the three-vessel $8 billion Air Warfare Destroyer (AWD) project. The new government would do well to look closely at the AWD project to see what it can learn.

The AWD Alliance [2] involves three parties, the Defence Materiel Organisation [3] (DMO), Raytheon Australia [4] and the government-owned but commercially operated ASC Pty Ltd [5]. The contracts are valued at $2.6 billion for ASC Pty Ltd and $1.7 billion for Raytheon Australia. Subcontractors to the Alliance include the US Government Foreign Military Sales [6] program for the Aegis radar and combat system [7], and the Spanish shipbuilder Navantia [8] for the design and some module fabrication. BAE Systems Australia [9] in Williamstown, Victoria and Forgacs Engineering [10] in Newcastle, NSW are also involved in module construction for the AWD vessels, which are being consolidated and fitted out in the ASC facility in Osborne, South Australia.

Under the alliance contract, the two commercial participants (ASC and Raytheon) operate under a pain-share/gain-share arrangement whereby their profits are at risk if performance is poor but benefits arise if the vessels are delivered ahead of schedule or under budget. In addition, liquidated damages may apply if a vessel is delivered late. Further details of the project can be found in the 2011-12 ANAO Major Projects Report [11] and in Chapter 7 of the 2013 ASPI Budget Brief [12].

So far, the project has been delayed twice as show in the table below.

Table: progressive delivery schedule for the AWD project

Original planned delivery date

2011 reschedule

2012 reschedule

HMAS Hobart

December 2014

December 2015

March 2016

HMAS Brisbane

March 2016

March 2017

September 2017

HMAS Sydney

June 2017

June 2018

March 2019

Source: Various Ministerial Media Releases.

Delays cost money, there’s no way around it. According to the Future Submarine Industry Skills Plan [13] (FSISP) released by DMO in mid-2013, the delays to the AWD program have resulted in additional costs of around $200 million. On the basis of workload estimates disclosed by DMO for completing the AWD and Landing Helicopter Dock (LHD) programs prior to and following the delays, around 2,150 additional work-years have been added (representing a 19% increase to the original estimate) for the two projects. Given no additional work has been announced for the LHD program, the increase presumably correspond to the AWD program.

According to the FSISP, the mounting delays to the AWD program are the inevitable result of the boom and bust approach taken to naval shipbuilding in Australia. But while the relative efficiency of a more continuous workload for the naval shipbuilding sector is a matter worthy of close examination, the cold start to the AWD program after a period of latency neither explains nor excuses the delays. The AWD project was developed slowly and carefully as a pilot project under the two-pass process. Around $211 million spent prior to project approval (excluding the purchase of long-lead items for the Aegis combat system) to gather information from industry and undertake design work. Everyone knew from the beginning that the project was a cold start, so any failure to properly estimate costs and schedule is a failure owned 100% by those who signed up to deliver the vessels.

When looking at the efficacy of the alliance approach, there are two questions for the new government to ask about the progress to date in the AWD program.

First, who is bearing the additional cost imposed by the delays? Under the pain-share/gain-share arrangements of the alliance framework, the commercial members of the alliance may have had to absorb some or all of the additional costs. But the project approval also included a contingency allowance held by DMO—perhaps as much as 10% or 15%—to hedge against cost blowouts. The extent to which industry or the taxpayer is picking up the tab for industry’s failure to deliver what they promised remains undisclosed. Could it be that the target cost estimates for the project have been relaxed to preserve industry profits at the taxpayer’s expense?

Second, given that the delivery of all vessels is now delayed, have liquidator damages been applied to commercial members of the AWD alliance? If not, why not? With 4.5 ship-years of accumulated delays, surely compensation is due.  What was the point of this provision if it’s not going to be used?

Without answers to these questions, it’s impossible to judge the effectiveness of the alliance framework. But one thing’s certain, given that the largest commercial member of the alliance—ASC Pty Ltd—is 100% government owned, the taxpayer is exposed to the bulk of any cost increases one way or another. Such is the delight of the Commonwealth contracting with itself.

Be that as it may, the effectiveness of the alliance still matters. Not just because it’s a testbed for future naval construction programs, but because the behaviour of the alliance members will be driven by the rewards and sanctions of the alliance framework. Irrespective of the taxpayer’s exposure through the ownership of ASC Pty Ltd, an effective alliance should provide company executives with reasons to seek efficiency and improve performance.

For better or worse, the Commonwealth is the ultimate bearer of risk in large defence projects like the AWD and Future Submarine. If things go catastrophically wrong, the commercial participants will simply not have the financial resources needed to make amends. In less extreme circumstances—such as those that have emerged in the AWD program—the question is whether the contracting framework provides adequate commercial incentives and sanctions to drive efficiency and protect the taxpayers’ interests. As things stand, we lack the information needed to make an assessment one way or the other.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of the Royal Australian Navy [14].



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URLs in this post:

[1] Image: http://www.aspistrategist.org.au/wp-content/uploads/2013/09/Hobart-class-DDG-artists-impression.jpg

[2] AWD Alliance: http://www.ausawd.com/

[3] Defence Materiel Organisation: http://www.defence.gov.au/dmo/

[4] Raytheon Australia: http://www.raytheon.com.au/

[5] ASC Pty Ltd: http://www.asc.com.au/

[6] Foreign Military Sales: http://www.dsca.mil/programs/fms

[7] Aegis radar and combat system: http://www.lockheedmartin.com.au/us/products/aegis.html

[8] Navantia: http://www.navantia.es/

[9] BAE Systems Australia: http://www.baesystems.com/home

[10] Forgacs Engineering: http://www.forgacs.com.au/

[11] 2011-12 ANAO Major Projects Report: http://www.anao.gov.au/~/media/Files/Audit%20Reports/2012%202013/Audit%20Report%2015/201213%20Audit%20Report%20No%2015_DMO.pdf

[12] 2013 ASPI Budget Brief: http://www.aspi.org.au/publications/publication_details.aspx?ContentID=359&pubtype=3

[13] Future Submarine Industry Skills Plan: http://www.defence.gov.au/dmo/id/fsisp/index.cfm

[14] Royal Australian Navy: http://www.navy.gov.au/fleet/ships-boats-craft/awd

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