13th New Zealand Defence Industry Association Forum
Tuesday 19 October 2010
Speech by Secretary of Defence, John McKinnon
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Thank you Doug for that introduction and thank you Mike for extending an invitation to me to attend and speak at this very significant gathering of those interested in defence industry in New Zealand. The Minister of Defence has just mentioned that how we undertake defence acquisitions is one important component of the Defence Review, and made some observations relevant to that. In this presentation I want to focus on one aspect of the topic - issues of defence organisation, especially as they relate to capability and procurement.
You will probably recall that one of the drivers for the Review back in 2008 was the concern that Defence Inc could do better in terms of procurement and acquisition than it had. There had been a number of reports which had highlighted problems, including that from the Office of the Auditor-General on the reporting of major projects, and the Coles review of HMNZS CANTERBURY. Partly as a result, in the terms of reference for the Defence Review, as they were agreed by Cabinet in March 2009, was a requirement for Defence to commission an independent report on procurement processes. At the same time one of the itemised workstreams of the Review was on defence organisation – the question of whether the current relationship between the Ministry of Defence and the New Zealand Defence Force was fit for purpose.
Before examining the conclusions of those reports I will recap the existing state of affairs. I do so because in my experience there are very few people outside Defence who understand how this works, and because the model we have is not found in any other country.
The current arrangements date from 1990, as part of the state sector reforms which took place at the end of the 1980s. One aspect of those reforms was to separate policy advice and/or regulation from operations: so as to prevent ‘provider capture' and to ensure that that policy advice and regulation could take place independently and transparently. It was not, as is often thought, primarily about generating contestability of advice as such, although that was at times a consequence.
In Defence that took the path of separating the policy advice function from the operations of the Defence Force and placing each in a separate organisation. What was at that time an integrated Ministry of Defence was thus split into a small policy ministry and a large Defence Force.
Another factor came into play at this point. The Public Finance Act, another key part of the late 80s state sector reforms, required that accountability for public money should rest with those who were responsible for it. That principle, which still guides our public finance arrangements, meant that the budget for the Defence Force, instead of being as it had been in the past the responsibility of the Secretary of Defence and the Chief of Defence Force (CDF), became the responsibility of the CDF alone, as the person responsible for what that money was spent on. The CDF was in effect made a public sector chief executive for those purposes. In this respect our arrangements are unique in the western world.
But there was one exception to this. Section 24 of the 1990 Defence Act, which sets out the functions of the Secretary of Defence, gives the Secretary the task of procuring items of significant military capability, be they ships, aircraft or vehicles. The reasons for establishing this carve out from what was otherwise a comprehensive allocation of functions and responsibilities to the Chief of Defence Force can be inferred, although they were never made entirely explicit at the time. But one was that the selection of expensive and potentially lethal items of military equipment are matters in which the government as a whole, and not just the Defence Force, have an interest. In effect the Secretary, in exercising that function, is carrying that broader public sector interest.
Whatever the reasoning, this carve out did present some challenges.
- While wide ranging the carve out was not complete. Items within the delegated authority of chief executives, namely $7 million, could be and are procured by CDFs as part of their standard inventory of responsibilities.
- Because capability development takes place within the Defence Force (indeed within each of the three services), acquisition within the Ministry, and introduction into service, in service support and disposals within the NZDF, a ‘pass the parcel' approach had to be developed as projects move from one organisation to the other and then back again.
Some of these challenges are inherent in any moderately complex public sector. There is always a need to balance vertical and horizontal separation and integration, and a variety of mechanisms to ensure that the interests of all stakeholders are appropriately represented. That in itself is no reason to change. But there are others, and they were highlighted in the two reports commissioned as part of the Defence Review.
Let me now turn to these reports and what they said on this matter.
The report from Michael Wintringham reviewing structural arrangements between the Ministry of Defence and the New Zealand Defence Force noted that making capital acquisition the responsibility of the Secretary was at odds with the principles of resource management, creating divided, and therefore unclear, financial and management responsibility for an important element of military capability. One consequence, Wintringham observed, is that from both sides of the institutional divide there was a propensity to see the acquisition of equipment taking place within a box, divorced from prior and subsequent processes. The problem analysis also tended to be weak for the same reason. In fact the range of issues which arise in the procurement process range from pressures of financial constraints, availability of expertise, to the need to build capabilities on a small asset base, as well as those which pertain to organisational arrangements.
The report from Aurecon and Hub Consulting on procurement processes looked more specifically at procurement and perhaps not surprisingly was even more trenchant in its observations of a dysfunctional and disjointed management of the capability life cycle across the two organisations. It observed that these disconnections inhibited the environment for continuous improvement in the capability system development and, in their view, were in part responsible for the poor outcomes associated with some recent acquisition programmes.
Before falling on my sword at this point I should note that we are not alone in having the occasional problem with defence procurement. And both reports also noted that we had often achieved successes - even if in their view it was in spite of ourselves.
Michael Wintringham said that for the most part New Zealand has bought useable equipment at a good price, even if at times the transaction costs for the system have been high. And to quote from the Aurecon Hub report, “the quality of acquisition outcomes achieved within the MoD Acquisition Group is surprisingly good given the state of its present level of resourcing and could not have been achieved without the personal commitments of a small core number of dedicated and experienced individuals within the present organisation.”
But clearly it is the overall view of both reports that we cannot rest on whatever laurels we might have. Where do they suggest we go?
In respect of procurement Wintringham's conclusion was that it did not make sense for what he saw as fundamentally a policy task, namely the identification of what capability was required to fulfil the government's policy requirements, to be undertaken by the NZDF, when there was a policy ministry for that very purpose; equally he could not see why the ‘operational' task of defence acquisition should be undertaken by that same policy ministry. He therefore recommended (amongst a number of other recommendations which are not pertinent here) that these functions should be reversed.
The Aurecon and Hub report, despite having a similar diagnosis, took an almost opposite approach: their key recommendation was to bring together the elements of both the NZDF and the Ministry which dealt with capability (including capability acquisition) so as to smooth the ‘pass the parcel' problem, while retaining the existing accountabilities of the Secretary and the CDF respectively.
Both approaches can be argued logically, but from my perspective the latter carries the more benefits. Let me explain why, in part by setting out the case against the alternatives.
First, the ‘silo' approach which is a consequence - not an automatic consequence but a likely one nonetheless - of the 1990 split, is unhelpful and unproductive. It raises transaction costs and can leave all parties feeling misunderstood and undervalued. Switching the responsibilities around, as recommended by Wintringham, would I fear simply reproduce those fissures, and the associated transaction costs, locating them in new places.
Second, to bat off the other extreme, placing all the functions in one organisation - which is what would match a private sector model - would not, I believe, be helpful either. While that model, specifically the integrated management of capital and operating expenditure, is very powerful, and can fruitfully be applied to much of the business of the Defence Force (as indeed the Value for Money review has argued) it is a fact that the Defence Force is not just any other organisation. It does not exist of and for itself, as a company does, but as a means of discharging a range of functions for the government of the day and more abstractly for the Crown. Clearly the NZDF will and should have strongly developed views on how it should be equipped to discharge its roles. But it is equally true that so do other public agencies, and the Crown itself. From that perspective, as I alluded to above, the Ministry acts as a proxy for that wider government interest in what the Defence Force is to do, what its capabilities should be and how they should be acquired, and what its funding levels should be.
Third, I do not favour a return to the ‘diarchy', the model which we used to have and which is familiar from Australia and elsewhere. The view of most of those in New Zealand who have examined these matters is that the clarity of accountability which flows out of our public finance and state sector model is not lightly to be given away, especially if we can mitigate some of the less helpful consequences. I would add to that, that a return to the diarchy would run the risk of again divorcing responsibility and accountability.
So fourth, I see the best way forward is to have a collaborative approach to the capability life cycle – the spectrum of investigation, decision and action which stretches from the genesis of a project to the disposal of an asset. Such an approach, very much what is recommended by Aurecon/Hub but with some modifications, would require that at every stage along the way both Defence organisations would have a voice. The need for continuous and effective cooperation between the Secretary and the CDF across the entire capability management process would be made clear in their formal accountabilities, and they would be required to introduce new working arrangements, building on those which already exist, to bring this new cooperative approach into effect. In many instances this would be given effect through the creation of joint staffs working under an identified and accountable project director or manager. (The recent consolidation of all capability work in NZDF into one capability branch would facilitate this approach).
This would not be about divesting or diluting the several and unique responsibilities of the Secretary and the CDF. These would remain, albeit there might need to be some legislative amendments to underpin this new construct. It is much more about driving cooperation and collaboration down through and between the two organisations, retaining the unique perspective of each, while gaining the benefits from working together.
This approach also sits well with the whole of life approach to capital asset management in the public sector, as just mentioned by the Minister of Defence. That approach means that we cannot look at a capital asset solely in terms of the upfront cost of acquisition. We have to be mindful of the costs of operating that asset throughout its life, and that again means looking at the spectrum of capability development and use as a whole, and not in segregated parts.
These potential changes are important. The shortly to be released Defence White Paper sets out a formidable agenda for Defence over the next decade and more. The NZDF needs the right equipment, people and infrastructure if it is to deliver the policy outcomes identified in the Defence Review. But Defence equally needs modern, focussed and responsive structures, in which all parts of Defence can play an appropriate part.
