There can be no doubt that the COVID-19 pandemic has shocked Australia into recognising the fragility of its supply chains across our entire economy.
The Australian community was understandably shocked to discover that many of life’s essential items suddenly became scarce due to supply chain issues.
In the post pandemic environment, it will become imperative that Government moves to assure greater resilience of supply and self-reliance in order that potential future shocks cannot leave Australia without supply of critical items.
Any discussion of critical supplies must include defence equipment, technology and know-how.
The Commonwealth’s procurement of all departmental supplies is governed by the Commonwealth Procurement Rules (CPRs), a Department of Finance Policy that emphasises Value for Money (VfM) as the primary consideration for government. Further to this Defence has a variety of its own policies on the topic:
• 2016 Defence Industry Policy Statement
• 2018 Defence Industrial Capability Plan
• 2019 Defence Policy for Industry Participation
There are also a variety of fact sheets on various topics all centred on Defence Industry.
Given the widespread investment by other countries in their own defence industries, foreign owned suppliers often have pre-existing equipment and technology and established overseas supply chains.
Further complicating these long-established supply chains is the requirement in many countries for industrial offsets to be factored into contract awarding, or offsets. This in effect drives certain behaviours as it a requirement for the winning tenderer to provide contractually guaranteed work for industries within another country.
For example, Canada has the Industrial and Technological Benefits (ITB) Policy which;
• supports the long-term sustainability and growth of Canada’s defence industry;
• supports the growth of bidders’ Canadian operations as well as their suppliers in Canada, including small and medium businesses (SMBs) in all regions of the country;
• enhances innovation through research and development (R&D) in Canada;
• increases the export potential of Canadian-based firms; and
• promotes skills development and training to advance employment opportunities for Canadians.
This policy was introduced 2014, and the Canadian Government is claiming that positive results are being achieved. The effect of the policy is ensuring that any potential bidders are engaging earlier with Canadian companies to form partnerships and identify high quality business investments up-front on a project. Looking at recent contracts awarded, there is strong evidence that the ITB Policy is encouraging:
• higher levels of work directly related to products or services for the Canadian Armed Forces;
• earlier commitments to R&D investments; and
• early commitments in export sales.
Historically, Canada’s defence offset policies have played an important role in leveraging economic benefit from defence procurements. From 1986 to 2017, the overall portfolio of ITB obligations includes 144 contracts valued at $43.8 billion, with $31.8 billion in business activities already completed, $8.8 billion of activities in progress, and $3.2 billion in unidentified future work opportunities.
As Canada enters a period of extraordinary procurement investments, the Government has established an aggressive target to increase by 40 per cent over 10 years the revenues earned by Canada’s defence industry.
Defence is not a level playing field
There are numerous examples of countries that have policies that contractually require this expenditure in the local supply chain, the US, UK and most of Europe have some form of policy that requires this.
Australia does not have a policy of offsets nor a requirement to include local suppliers into programs, however the policies it does have requires Defence to conduct analysis that justifies which companies are selected. There can be no doubt that unless Defence adheres to the Government’s own policies Australian industry will continue to find itself in more and more precarious positions.
On face value there appears to have been a rather simplistic assessment of VfM based on the short-term, upfront acquisition price and does not properly factor in the greater through-life support costs of being dependant on overseas suppliers nor the resulting lack of self-reliance. Government policy in this area requires that all Government departments undertake a broader benefit to the Australian economy and specifically that all officials are required to consider the economic benefit of the procurement to the Australian economy.
It is unclear how defence meets this requirement however given the policy’s specific requirement to undertake this review, Defence should be able to produce this analysis.
Defence to their credit have identified industrial capabilities that are critical, Sovereign Industry Capability Priorities (SICP) which must be developed in Australia and developed an Australian Industry Capability (AIC) policy that is intended to ensure overseas Prime Contractors develop a viable plan to ensure that Australian industry is properly considered in the development of the associated supply chains.
Current state of play
Unfortunately, during actual defence procurement decision making, these policies do not appear to be scaled on the same level as short-term VfM considerations.
Often Defence is placed in a position where it must choose between meeting cost/schedule on the one hand, and meeting AIC/SICP considerations on the other. Only Government direction can break this nexus.
Prime contractors will often submit substantial AIC plans and these plans in the majority of cases are well thought out and require dedicated resources and time to implement. But again given the imposed constraints of cost/schedule, they find that it is simpler to employ established overseas supply chains to de-risk their programs. Given these competing issues, and invariably at short notice, Defence has little to no option to agree to departure from the submitted AIC plan during the contract negotiation phase.
This cycle of producing viable AIC plans only to have them systematically watered down has led to the situation were Australian industry is repeatedly frustrated at being held out by these short-term VfM driven decisions that exclude Australian suppliers, whilst repeatedly being told by both Government and Defence that the pursuit of AIC is a policy requirement.
Government needs to insist that defence procurement decision-making be based on more than short-term financial VfM considerations and that the greater benefits to the Australian economy be a fundamental requirement to the decision making and that an auditable report is produced.
The resilience of supply chain for defence systems and the associated through-life support costs must be explicitly incorporated into procurement decision making and rank equally with the short-term cost/VfM considerations.
A cost premium reflecting the risks to national resilience and through-life support costs arising from offshore acquisitions must be formally factored into cost comparisons of competing bids. This cost premium needs to be fully understood by all parties.
The existing AIC policy framework is a good starting point for an adjusted procurement framework to match.
An independent party outside of the Defence procurement agency must be given powers of monitoring and enforcement of the policy.
Urgent intervention is required to achieve AIC in the current $200 billion of major Defence acquisitions.
By comparison to other critical sectors (e.g., medical equipment), the Defence sector offers a strong prospect that actions taken now can positively improve national resilience. As the end customer is the Commonwealth, Government is in an inherently strong market position to drive the resilience outcome it seeks. Unlike health, the Commonwealth is a monopsony in that there are no other customers for complex defence platforms in the country.
The prior work conducted by Defence into its industry structure, including into identifying SICPs and crafting AIC policy, provide a mature starting point for the Resilience Working Group’s own recommendations.
In addition to generating national resilience, these recommendations will yield a massive economic dividend, which given the likely state of Australia’s economy post COVID-19 will be vital to ensure that the country recovers in a timely manner and that the lives of the ordinary Australian taxpayers can recover financially as quickly as possible.
Defence’s Integrated Investment Program (IIP) has $200 billion of expenditure outlined, of which under current approaches could potentially lead to around 60 per cent of the value of these activities going offshore. An increase of 25 per cent Australian industry content will lead to an increased $50 billion of economic manufacturing activity in Australia.
Decisions being made on major programs over next six months will “lock in” overseas supply of approximately $450 billion – and once again, leave Australia exposed to the vulnerabilities of overseas supply of critical defence systems for the next 30 years.
Government already has the policy framework in place to ensure that this activity is undertaken in Australia by Australian companies, it merely has to enforce compliance to its own policies.
Note: Brent Clark is the new CEO of AIDN National, CEO of Industry Voice and has worked for both Primes and SMEs after his career in the RAN as a submariner.