Naval deconstruction: RAND’s shipbuilding report
5 May 2015|
Monopoly, anyone?

Commissioned in September 2014 under a $2.5 million contract, the RAND report Australian’s Naval Shipbuilding Enterprise: Preparing for the 21st Century was released on 16 April 2015.

The government says it’s developing an ‘enterprise-level Naval Shipbuilding Plan… informed by the expert, independent advice from the RAND review’. It’s important therefore that RAND’s analysis is carefully evaluated. With this in mind, I’ve prepared a critique of the RAND report for inclusion in next month’s ASPI Defence Budget Brief. But with the clock ticking on shipbuilding policy, I’ve decided to release the current draft. RAND have been invited to respond on the Strategist. Comments are welcome.

The 297-page RAND report comes to several policy-relevant conclusions. For the purpose of this blog post, two stand out:

  • Building four Offshore Patrol Vessels commencing in 2017 would provide a ‘cost-effective transition’ between the end of the AWD program and the commencement of the future frigate program.
  • Adopting a ‘continuous-build’ program for the future frigates and subsequent classes of surface combatant would help create a sustainable naval shipbuilding industrial base.

Since a viable and cost-effective domestic naval shipbuilding industry would be a good thing, I’m sad to report that the RAND report doesn’t provide a persuasive case for either course of action.

The proposal to build four OPVs is predicated on maintaining skilled workers in the sector to (1) reduce the labour cost of the subsequent future frigate program, and (2) reduce the delays in the future frigate program predicted by RAND’s computer simulation.

RAND fails to quantify either the savings or the cost of the four OPVs. But estimates are possible under reasonable assumptions. Using the average per-capita labour rate paid by ASC Limited in 2014, the savings amount to only $89 million (c.f. RAND’s estimated $5.5 billion labour cost for the future frigates). And based on the £348 million cost of the comparable three-vessel UK program, the four vessels would cost in the vicinity of $890 million at today’s exchange rate. Thus, the net cost of the proposed four vessels is around ($890 million – $89 million) = $801 million—for four vessels we didn’t previously know we needed. As for the predicted delays, for technical reasons I explain at length in my critique, RAND’s predictions should be viewed with scepticism.

To create a ‘continuous build program’, RAND proposes that the Future Frigate program be slowed from a 12 month to 24 month pace of ship delivery. This is a truly bizarre suggestion. Setting aside the additional cost and capability shortfall from not replacing the existing Anzac-class frigates when they retire, the end result is that the final Future Frigate will be delivered 6 years before the first AWD is due to be retired. That’s the same gap that we now face between the end of the present AWD program and the first delivery of a future frigate. Under the RAND plan, it would be a case of ‘back to the future’, where 2020 becomes 2040 and nothing has changed.

Of course, to actually create a continuous build program, ships would need to be replaced more frequently and/or the number of vessels in the fleet would need to grow—but either option would cost billions of dollars more.

So why would we even think about buying OPV vessels or moving to a continuous build (or slow non-continuous build) program? RAND says that by adopting a continuous build program and reforming shipbuilding practice, the current 30% to 40% cost premium (RAND’s estimate) for domestic shipbuilding could be reduced by half by mid-way through the Future Frigate program. That’s a big saving: if frigates cost $1 billion each absent a premium, they’ll cost around $1.35 billion with a 35% premium and around $1.175 billion with half that premium. Across just the last half of the program, that would amount to savings of 4 x $175 million = $700 million.

But wait a minute: if the OPV program delivers only $89 million in savings over the entire eight-vessel Future Frigate program, then the vast bulk of the savings must be due to the reforms to shipbuilding practice rather than continuity. RAND’s own conclusion implies that continuous construction has only a marginal impact on cost. So why bother?

Perhaps the biggest disappointment in the RAND paper is failure to grapple with the commercial arrangements surrounding shipbuilding. A real continuous build program would effectively create a monopoly national shipbuilding enterprise. RAND’s central planning approach to shipbuilding fails to acknowledge the difficulty of managing a monopoly shipbuilder sheltered from competition. Great care is needed.

A lesson from the United Kingdom illustrative. The idea of building OPV as a gap-filler isn’t a new idea. The United Kingdom is building three OPVs ‘to sustain key industrial capability’ between the end of the Queen Elizabeth class aircraft carrier and beginning of the Type 26 frigate program. The oldest of the vessels the OPV will replace is only 12 years old. But there’s more to the story—under an agreement with the shipbuilder, the United Kingdom would be ‘liable to pay the costs of maintaining these skills whether or not any shipbuilding was taking place at UK yards’.

While Soviet-style planning might look good on paper, commercial realities can make things much more difficult.