Making The Sums Add Up - the NAO Report on the Equipment Plan

 

The National Audit Office has released its latest annual assessment on the viability of the MOD’s equipment programme. Assessing how credible the plans are to spend nearly £200bn of public money over the next 10 years on equipment, and how likely it is to make the books balance. Sadly, the NAO has, for the 4^th year running, concluded that the Equipment Plan (EP) is unaffordable.

The British Armed Forces benefit from possessing extremely capable armed forces, capable of operating globally and being able to carry out a wide range of missions, from peacekeeping to warfighting. The equipment that they use is particularly good, and often some of the best in the world for the job at hand.

Image by Ministry of Defence; © Crown copyright

The span of interests that must be looked at ranges from the production of armoured vehicles or upgrades to tanks and artillery, through to developing cutting edge aircraft, nuclear submarines and also space and cyber capabilities. One of the challenges of being a globally facing military power, operating on all continents and from the depths of the ocean to the cold depths of outer space is that this can cost an awful lot of money. The EP is a complex mammoth beast that covers hundreds of different projects designed to bring new equipment into service to meet these needs.

The programme is run on a rolling 10-year cycle – essentially looking out over the next 10 years, identifying what projects need to be funded, when they need to be funded, and how much is required in each year. They then pull all of the different funding requirements together, identify how much needs to be spent in each year to deliver as planned against various timelines, and then see if there is enough cash to fund as needed.

A common misconception is that when a project is begun, there is a lump sum of cash allocated to it, paid up front. Instead, what happens is each year is each project requires different levels of spending – some years it may need 10-20% of the total cost committed, but other years may only need 1-2% found.

The challenge is when you’ve got hundreds of different projects, each of which has a different spending profile, and different delivery dates, and all of which need to be considered to work out what happens if you move a delivery date by a year or spend less. Much like chaos theory and how a butterfly flapping its wings in China causes a hurricane in New York, a move of one year on an obscure Army project can set in chain a bow wave of events that makes other projects unaffordable and lead to their cancellation.

The big problem that the MOD has now had for several years is that no matter how it tries to resolve the problem, the numbers it is coming up with are consistently falling short of how much it thinks is required. Even by its own best estimates, the MOD currently believes that it has £7.3bn less than is required to fund all the projects it currently expects to buy. This is not good news.

To make things more complicated still, the NAO has identified that the MOD has based a lot of its assumptions on how the programme can be affordable on some potentially quite risky judgements.

For example, a large part of the funding expected to be found comes from savings measures being applied to programmes – either to drive their costs down, or to free funds up. In the plan, the MOD has reduced costs by about £8bn on the assumption that it can save this by making efficiency measures during the procurement phase. The problem is that there isn’t any evidence that they can be found.

The report notes that the MOD has yet to come up with any form of plan to identify or deliver roughly £3.7bn in savings. That means that across the whole plan, significant extra chunks of savings need to be found, or changes made that could impact on delivery of the project. This is a very substantial sum of money to be found, and if these savings cannot be realised, then the EP becomes even more at risk.

The bigger problem for these efficiency measures is that some need to be found in the near future. For example, the report notes that in the next 2 years, the Mod has identified that a further £500m in savings, on top of the £1.6bn already identified as needing to be found in the EP to help drive down costs.

Injecting a requirement to essentially find a further 25% in cost savings has potentially to seriously disrupt a lot of projects – either by delaying them (thus kicking the problem down the road) or reducing what is purchased (which could cause issues with industry and longer term support and defence output) or finding some other way to muddle through this. No matter how you look at it though, its not an ideal place to be.

This desire to draw out efficiencies from projects is perhaps a curious irony of the EP. On the one hand there is a need to keep bringing new and very good equipment into service, but on the other, it is being done against the backdrop of ever tighter pressure. The NAO note that in 2016 the MOD planned on trying to realise some £5.8bn of efficiency savings in the 10yr plan, that has by this year grown into finding £12.8bn in savings.

The problem is though that there is no clear plan in place to credibly find where this money is coming from. Its akin to trying to build a Lego model while still paying for it on credit, at the same time as constantly changing and reducing the number of parts you want to pay for, and features you want it to have – at some point its going to end in tears.

Image by Ministry of Defence; © Crown copyright

This problem looks even more serious when you analyse the MOD’s financial position. There is some £5bn ‘contingency’ funding in place to provide central pots of cash to help out with unexpected costs or help speed projects up over the next 10 years.

The problem is that none of this is available this year, and the MOD began FY2020/21 by having used up all its contingency funds, meaning there is no spare cash to either buy out a risk, or help solve a problem in year- instead, this needs to be found by raiding other budgets or cutting elsewhere. As such there is a significant risk attached to how MOD can fund emerging problems if identified.

The overall financial position does not look good. The report notes that even with the contingency for the current financial year fully attributed back in April, the MOD began the year £250m overspent – which means that all this year, significant in year savings measures (e.g cuts) have been needed just to stay financially afloat.

The NAO quietly notes that even with budget growth confirmed, the MOD had to deliver over £1bn of in year cuts and savings to Defence activity in FY2020/21, with huge cuts being made to project spending, and deferred delivery on other areas.

Meanwhile the NAO is equally caustic about the state of budget area funding – it notes that the Royal Navy is in a particularly difficult position, being some 12% overspent on its budget plans – this means that if savings cannot be found, very difficult decisions are needed on what will, or will not, survive in order to keep the budget steady.

For all the ‘fantasy fleet’ talk of up gunning RIVER class, or buying lots more Type 32s, it is clear that the discussion is on saving money in huge amounts, not creating lots more ships and missiles, for the money simply does not exist. Rather this is about capability reduction through financial efficiencies.

Looking to the bigger funding picture and the news is, again, not ideal. The NAO notes that the Equipment Programme has been funded on the assumption that there will be cost growth in the budget over the next 10 years, and that currency fluctuation and other changes will be absorbed by HM Treasury.

In the last year, planned MOD spending commitments in the EP have grown by £10bn, while the NAO notes that there is not sufficient funding in place to start new projects without disinvesting in other ones.

The problem is that the NAO has highlighted that there are significant gaps in funding plans, for example there is no funding in place for replacement Mine Warfare capabilities, any further order of F35 Lightning aircraft and decisions on Tempest or the replacement nuclear attack submarine programme, all of which need to be committed to this decade.

While some of these decisions are policy or politically based and will probably be waiting for a clearer sign from the Integrated Review about what will, or will not, survive the review and which will be funded, it still indicates a challenge that there are many different essential projects likely to get the greenlight for which no funding is currently available or planned.

For example, if the IR decides that more than 48 F35s are required, then space needs to be found to pay for them. As there is no extra money to pay for them, something else needs to be cut from the budget to cover it, pending an unexpected supply of new money.

Image by Ministry of Defence; © Crown copyright

What this means is that the next EP is likely to be a vastly different document, reflecting the potentially brutal decisions that will need to be taken in the Integrated Review about ‘sunrise and sunset’ capabilities.

The slightly bland phrase ‘sunset’ is based on the reading of this NAO document likely to herald very significant cuts to defence capability and support both in the short term to balance the books, and in the medium term to find space for other equally important projects.

Much attention is paid to the announcement that the MOD has benefitted from the £16.4bn uplift last year to its budget, and rightly so. This was a very generous budget settlement, far in excess of what was realistically expected, and which is greater than other Whitehall departments got.

This is the problem that the MOD now has. It has got a very good budget settlement and it has assumed that its budget will continue to grow for the next 10 years – even with this, it is still a minimum of £8bn in the red when it comes to its EP.

How this problem will be solved is unclear. There is clear political support for Defence and what it can deliver in terms of outputs and solutions. But it will need to pare back its aspirations and ambitions significantly if it wants the budget to be balanced off correctly. At the same time though, there is a strong push to achieve the ‘Global Britain’ narrative of being globally present and using the military as a key tool of British security policy.

The IR when it is presented is likely to have to provide clarity on the way forward. Will it herald genuine changes, that reduce and cut back the military, removing vast swathes of people, equipment, and missions in order to save money and realise efficiencies to balance the books? Or will it retain the aspiration and keep hoping that something will come along to buy out the risks and ensure that funding isn’t an issue? These are, without doubt, difficult and interesting times to work in Defence finance.

Image by Ministry of Defence; © Crown copyright

The problem though is that there aren’t enough people working in Defence finance – the NAO notes worryingly that one in three financial posts, essential for ensuring that things work as planned, is currently vacant across the TLBs, while only 40% of financial staff have financial qualifications.

With a nearly £200bn programme and global span of responsibility and capability to responsible for, it is mildly concerning at the lack of staff, let alone fully trained staff. This once again highlights the critical importance in finding and supporting properly trained, and remunerated MOD Civil Servants to do this work – without these unsung heroes, the problem would be even worse.

The MOD probably faces a somewhat schizophrenic few years ahead of it. On the one hand, it has got a very generous budget outcome, which will help fund major improvements to its capabilities and ambitions.

On the other hand, it remains in a state of near perpetual crisis when it comes to realising in year budgets and will find itself constantly forced to make in year cuts that reduce activity, output and morale, in order to stay solvent.

The IR is an opportunity to reset the EP – by providing political top cover to delete multiple projects, remove significant costs from the EP and then use this new direction to fund ambition elsewhere. If done sensibly, then the opportunities over the next few years are huge.

There is opportunity ahead – a balanced EP, with new capabilities like robotics, autonomous drones, cyber forces and North Atlantic Surveillance properly funded will be a game changer for so much of what Defence aspires to do. But to get there is going to require some painful defence cuts to find the space and headroom to make it happen.  What is not clear is whether this is deliverable, or if the MOD will continue to exist in a state of financial challenge.

This challenge becomes even more considerable when put in the likely context of the post COVID world. With economic pain ahead, and more financial challenges likely, the MOD is probably not going to get a large budget boost anytime soon. Instead, it will be scrabbling for resources alongside other equally worthy departments.

If anything, the next few years may prove to be equally difficult as costs rise, budgets fall, and the global security environment becomes even more complicated than it is now. One must hope that the MOD has gotten its sums right, or things could become extremely complicated indeed.