Defence cost ‘blow-outs’ explained
23 Oct Defence cost ‘blow-outs’ explained
Posted at 22:34h
in QSO World
By Marcus Hellyer*
Every year the Australian defence commentariat replays a ritualised dance that goes like this. First, the Australian National Audit Office releases its major projects report providing detailed information on the progress of around 25 of the Department of Defence’s largest acquisition projects. It includes a table titled ‘Budget variations post second pass approval’ (that is, government approval to commence acquisition of a particular capability). Last year, the table summed to $24.2 billion.
The media then performs its role and publishes stories about defence budget ‘blowouts’, reinforcing the public’s deeply held view that Defence couldn’t manage a kindergarten bake sale without the cost blowing out by several billion dollars.
I then run a piece in The Strategist explaining why the dollar figure for projects exceeding their approved budget is actually much lower. The term Defence uses for this is ‘real cost increase’, which is way less sexy than ‘cost blowout’.
Most of the variations come from two factors. The first is increases in scope. You want an additional 58 F-35As? You need to pay for them by increasing the project’s budget. That’s not a blowout. It’s a staged acquisition strategy (or, occasionally, an opportunity to use the defence portfolio’s underspend before it evaporates).
The second factor is fluctuations in exchange rates. Defence is compensated for a decline in the Australian dollar in order to preserve its buying power. This isn’t a blowout either. It shows up as a budget increase, but it’s not a ‘real’ increase (and with the Aussie dollar plummeting against the greenback, get ready for some extremely large upward adjustments in the October budget). The truth is, very few of Defence’s acquisition projects actually require real cost increases.
Since hope springs eternal, I thought we might be able to escape this version of GroundhogDay if I set the issues out in plain English—which I did in a report earlier this year on the cost of military equipment.
Despite that, the dance started a little earlier this time around when the government pre-empted the ANAO by releasing to the media a list of $6.5 billion in ‘blowouts’ that occurred under the previous government. While the figure is less than the ANAO’s $24.2 billion, most of the increases in the latest list are again due to changes in scope and adjustments for exchange rates rather than real cost increases. For example, the $2,366 million increase for the F-35A is mainly exchange rate compensation. The $1,784 million increase for the P-8A Poseidon maritime patrol aircraft is due to the acquisition of additional aircraft and exchange rates. It’s a similar story for the EA-18G Growler electronic attack aircraft.
The figure for real cost increases for the projects on the ANAO’s latest list is only a small fraction of the $6.5 billion. Other than a $243 million increase for the civil–military air traffic management system that occurred nearly five years ago, there’s not much there. Defence’s biggest real cost increase was $1.2 billion for the air warfare destroyer project—but that’s not on this list since the project is complete. And once that project’s numbers are finalised, it’s likely it won’t need all of that.
Incidentally, one element that is consistently overlooked in the dance is that projects going over budget are more than outweighed by projects that underspend against their approved budgets. Indeed, the Growlers and P-8As will come in under budget, not over.
Schedules are a more problematic issue. The government’s list has a total of 1,173 months—almost 98 years—of delays. It’s no secret that many defence projects have experienced delays, but even here the issues aren’t black and white. For some projects there are straightforward explanations. Take, for example, the P-8A project. The government ordered six additional aircraft after the initial eight. If you order them later, they will be delivered later, so the original date for final operational capability will necessarily move.
Even the projects with real delays generally have delivered most of their intended capability but haven’t been closed out because there are some outstanding elements. The MRH-90 Taipan helicopter project has a 123-month delay to full operational capability, but its 47 helicopters were delivered years ago and have been in service (their unreliability and high cost of operation that prompted the previous government to announce their early retirement is a separate but not entirely unrelated issue). The Collins-class submarine reliability and sustainment project is 108 months late, but it’s a program delivering a large number of improvements and upgrades, most of which were successfully completed long ago.
But that doesn’t mean there’s nothing to see here. There are issues that need attention. On cost, the public obsession with blowouts reinforces the wrong behaviours in Defence. It develops second-pass cost estimates extremely conservatively, putting risk margins on top of risk margins so that there’s virtually no prospect of going over budget. But that can tie up funds that could be used for other priorities. If Defence was operating with a more commercial mindset, it would accept a little more risk and estimate its costs a little more leanly. But that would mean the government (and the media and the public) would need to accept that some projects would go over budget.
We also shouldn’t ignore the fact that Defence’s estimates have often increased significantly before the second pass. For example, Deputy Prime Minister and Defence Minister Richard Marles referred to a $15 billion increase in the estimate for the future frigate program from $30 billion to $45 billion. That’s not unique. As a project moves from the recognition of a future capability gap that could have many possible solutions to identification of the actual equipment to be acquired, Defence’s assumptions about threats, requirements, technology, quantity, and so on can change. Consequently, the cost estimate will change, often dramatically. This isn’t a budget blowout per se, since there’s no approved budget to blow. But when numerous projects behave this way, it puts pressure on the overall affordability of Defence’s capability plan. The scrapped submarine program went from $50 billion (inflation-adjusted dollars) to $80–90 billion. A similar trajectory for the nuclear submarine program will be very hard to manage.
Regarding schedule, many delays are real and affect delivery of frontline capability. As repeated reviews have pointed out, there are many factors at work: Defence seeking 110% solutions when a 90% solution will do; industry overpromising; a lack of enough qualified people in Defence and industry to deliver; excessive process and documentation requirements; and so on.
The delays illustrate the disconnection between our current strategic circumstances and Defence’s business processes. If we don’t have warning time for impeding conflict, we can’t keep choosing capabilities that take so long to deliver—whether they’re on time or not.
So it’s a good step that the government also announced a range of measures aimed at improving Defence’s performance. These involve more frequent and earlier reporting to ministers. Closer government attention is a good thing, but nothing focuses the mind like greater public scrutiny, so it would also be good to see more information provided to the parliament and public.
Any solution will require multiple lines of effort. Perhaps the most important one will involve all of us abandoning our peacetime mentality around risk and reward. We can’t keep making the same kinds of acquisition choices and employing the same business processes that got us here. A new approach will involve a different risk appetite from the government, parliament, Defence, the media and the public.
As the old saying goes, ‘You want fast, cheap and good? Pick two.’ If we want capability fast, we either need to moderate our requirements or accept that it could cost more. If getting capability faster results in sometimes having to pay more than expected, we all have to resist the temptation to run easy headlines about cost blowouts—otherwise, Defence will never change its risk-averse behaviours.
*Marcus Hellyer is ASPI’s senior analyst for defence economics and capability.
First published by the Australian Strategic Policy Institute