Independent, fair, transparent: regulating single source defence procurement

Marcine Waterman, Chief Executive of the SSRO, delivered a speech at the DSEI Conference. She discussed the SSRO's work and priorities.

Good afternoon everyone. I’m Marcine Waterman, Chief Executive of the Single Source Regulations Office. Thank you for coming to this session, during which I will be explaining about the work of the SSRO and what to look out for over the next few months. I plan to talk for about 20 minutes, and will provide an outline of the main areas of our current work. They include:

  • a review of the way the baseline profit rate for single source contracts will be calculated
  • publishing our first annual compliance report

I’ll also provide an overview of our day to day work – touching on:

  • qualifying defence contracts
  • our role in referrals for determinations and opinions
  • our current priorities and work programme
  • our early findings

I will then have about ten minutes for questions and answers – I’m very keen to hear from you.

The SSRO is the guardian of the single source procurement regime.

We were created by the Defence Reform Act, which was granted Royal Assent in July 2014, and the Single Source Contract Regulations were then introduced in December 2014.

This is the first time the single source defence market has been regulated on a statutory footing in the UK.

We want all parties to a qualifying defence contract to know and understand the Regulations, and to feel that they are fair and balanced to both industry and the MOD.

The first statutory aim given to the SSRO is to ensure that good value for money is obtained for the taxpayer in government expenditure on qualifying single source defence contracts.

Just as important is our second aim – to ensure a fair and reasonable return for industry on single source contracts. We want to foster a regime that enables the British defence industry to prosper and remain competitive in both national and international markets.

I believe that industry will benefit from a regime that:

  • provides more certainty about how things will be procured
  • creates greater confidence, on all sides, in single-source procurement
  • lowers the risk of ‘moving the goalposts’ in contracts and delivers greater certainty to suppliers, including clarity of what costs the MoD will meet
  • ensures standardised reporting procedures
  • provides a fair deal for industry
  • provides for an independent adjudicator in the form of the SSRO, sitting at the intersection between government and defence suppliers

Overarching all of these benefits, the regime will enhance the credibility of single source procurement.  

The SSRO has a range of statutory functions, which can be placed into 4 broad categories.

First, we set the rules – this includes reviewing the Single Source Procurement Framework, recommending profit rates and issuing statutory guidance.

Secondly, we monitor the application of the new framework, and adherence to it – this includes our annual Compliance Report.

Thirdly, we adjudicate, acting as the appeal body and delivering opinions and determinations on different aspects of a contract. These can only arise following referrals by either MOD, industry or both.

Fourthly, we provide detailed analysis – which is gained through the information gathered in the contract reports.

I thought I’d say a few words about the SSRO’s independence.

Our independence is enshrined in the Defence Reform Act and the Framework Document between the MOD and SSRO, which states:

The SSRO will operate independently and not under day-to-day ministerial control… although the SSRO will be overseen by the MOD for governance purposes, it has operational independence.

In meetings with MOD Ministers, we have been assured that they understand the need for SSRO independence. MOD officials understand this too.

We have worked hard to ensure our independence and we have discussed it in our meetings with industry, who have raised no concerns or queries.

We are a compact and efficient organisation, with all governance structures in place and functioning. Our Board and its three sub-committees – the Audit Committee, the Regulatory Review Committee, and the Referrals Committee – are established and have been in operation at least since the beginning of this year.

We have also recruited all our key staff and we now have 30 people delivering the SSRO’s workplan. They are high calibre individuals, who hold the necessary skills and experience across a range of specialisms – including regulation; finance and accountancy; policy; economics; and analysis.

In the parliamentary debates about the reforms the figure of £6 billion for single source procurement per annum was cited. The figure has increased since then, and this slide uses data from the MOD to show two things:

  • First, the value of new non-competitive contracts placed in 2014/15 was around £5.4 billion
  • Secondly the total spend on both existing and new single source contracts was around £8.3 billion in 2014/15

This equates to almost half of MOD’s total spend. It is therefore vital that any acquisition is done effectively to ensure value for money and that the armed forces get the equipment or service they expect when they need it. It is also worth noting that the amount spent via the non-competitive route is increasing.

One of our key statutory roles is to recommend the baseline profit rate for single source defence contracts. The baseline profit rate is common across all single source contracts and is the starting point for determining the contract profit rate to be applied in the price for a single source contract.

In January of this year we recommended that the baseline profit rate for single source defence contracts for 2015 should be 10.60 per cent, which was a 0.10 per cent reduction on the rate for 2014. I’m pleased to say the Secretary of State for Defence accepted the rate.

Given the timing of when the SSRO was established we were only able to shadow the work of the Review Board in determining the profit rate for 2015 rather than perform our own detailed analysis.

The current approach to calculating the baseline profit rate has been broadly unchanged since it was introduced in 1968 when the nature of UK industry in general, and the defence sector in particular, were very different to the situation today.

The approach to calculating the rate was established at a time when there were more defence contractors, industry was less global and the UK’s manufacturing base was very different.

The defence industry now operates within a global economy, with a more diverse industrial sector and a substantial services sector.

Thus, whilst it is likely to be proposed that the new methodology should continue to be based on the principle of comparability it is also likely to suggest that the comparison be made with companies whose business is more similar to that of defence contractors.

The current approach recommends a single baseline profit rate for every type of defence work regardless of complexity and risk. However, defence contracts are increasingly varied in nature and in the level of risk and complexity.

The new methodology is likely to propose a different baseline profit rate for different types of work. Differentiating by work activity means a tighter and more relevant group of comparator companies would be used to calculate each rate.

The yellow book regime only benchmarked profits against companies with headquarters listed in the UK – it did not include companies with headquarters outside of the UK but whose business activities are comparable, and which would have been included had they been listed in the UK. We will use comparator companies operating in the UK but also Western Europe and North America, as the defence industry is now more global.

We are finalising our proposals over the next few weeks and will discuss them, in outline terms, with representatives from industry and government at the SSRO Senior Stakeholder Forum on 17 September.

The proposed new methodology will be subject to an eight week consultation, open to all interested parties, commencing on 25 September. I do hope that you will contribute.

Following the consultation, the SSRO Board will meet in December to review the responses and finalise the methodology.

In January 2106, we will publish the final methodology and will make recommendations on the profit rate for 2016/17 to the Secretary of State for Defence.

Both of our central statutory functions relate to the regulation of Qualifying Defence Contracts, or QDCs as they are often referred to.

As such, QDCs are the bedrock of our work.

We currently have oversight of 4 QDCs.

The volume of QDCs is less than we had anticipated. We expected 50 to 60 QDCs in our first 12 months of operation. We are keeping a focus on how many contracts are becoming QDCs and expect to be monitoring more in the near future.

We are receiving the required reports from the QDCs we have oversight of, and are working collaboratively with industry and the MOD to ensure compliance to the Regulations.

In examining the reports we have already identified non allowable costs, which will result in savings for the taxpayer.

The SSRO’s guidance on Allowable Costs provides the principles which contractors and the MOD must have regard to when determining whether costs are ‘allowable’ under qualifying contracts and sub-contracts.

The guidance provides principles, rather than rules.

The Act states that Allowable Costs must be ‘Appropriate, Attributable and Reasonable in the circumstances’.

The guidance includes a range of examples and checklists to help users assess if costs meet the criteria specified in the Act.

For example, we have specified that entertainment expenses of any sort can never be determined to meet the Appropriate, Attributable and Reasonable criteria.

The benefits from allowable costs guidance are twofold:

  • First, providing assurance for both the MOD and the taxpayer that value for money is sought in qualifying defence contracts
  • Secondly, giving certainty to defence contractors that what they are costing is allowed and chargeable

We will continually review the guidance throughout the year, and update the document when necessary.

We have also published SSRO Answers, which helps to clarify our intent on many of the issues that are reported to us. We will keep the guidance under review and update it where necessary.

A contractor or the MOD may refer certain issues to the SSRO for us to give an opinion or determination on the matter.

Examples of determinations that may be sought by making a referral to the SSRO include:

  • adjustments to contract profit rate calculations; and
  • determinations on the extent to which a cost is an Allowable Cost under a QDC

We have issued guidance that sets out the role and authority of the SSRO in the referrals process.

We have established an SSRO Referrals Committee to consider any matter referred to the SRRO for an opinion or determination. The Committee will include at least one independent panel member.

A summary of any opinion or determination made by the SSRO will be published, but without any confidential information. The SSRO Referrals Committee will be fair, hear representations from both parties, and remain impartial and independent.

We have also introduced a Defined Pricing Structure, which will eventually be used across 16 different platform or equipment types to benchmark costs and analyse value for money in single source contracts.

The aim is to establish a single, centrally available, comprehensive data set to determine relationships between costs and outputs, and record the estimated and outturn costs broken down by category, for each QDC.

This will enable future analysis such as benchmarking, while assisting effective contract monitoring without being overly burdensome.

We published the first two Defined Pricing Structure templates - covering submarines and surface ships - and a principles document, in June 2015.

We are currently developing the templates and are meeting with defence contractors and the MOD  to listen to feedback. We aim to have all templates published by the end of 2015.

The SSRO is required to publish an annual Compliance Report, which sets out the extent to which contractors and the MOD have complied with the provisions of the Defence Reform Act and Single Source Contract Regulations.

The report is key to the SSRO’s aim of a transparent and accessible regulatory framework and we believe it will encourage compliance on the part of defence contractors and the MOD. We will provide help and guidance to MOD and defence contractors to assist them in being and becoming compliant but we will not hesitate to publicise repeated wilful noncompliance with the regime.

We have created a methodology to measure compliance, from which data and rating scores will be produced. We put the methodology out to a public consultation period that lasted from 29 June to 25 August 2015.

We are considering our response to feedback received during the consultation.

The first Compliance Report will be published in January.

Our stakeholder engagement plays a crucial part in building our expertise and confidence in the SSRO.

We have established a Senior Stakeholder Forum, which meets on a twice yearly basis and comprises representatives from MOD, industry, and the SSRO. The first of these was held in February and received very positive feedback. The second is to be held later this week, here at the conference.

An operational working group, which meets on a more regular basis, offers an opportunity for a similar group of stakeholders at working level to come to our offices and raise issues or seek clarifications on any of the regulations.

The Chairman and I have met with around 30 contractors on an individual basis, through a number of head office and site visits.

We have had some direct interaction with the military during our training at the Defence Academy in Shrivenham where we heard their views on the new regime and their thoughts on defence procurement.

We are looking to strengthen our engagement with SMEs.

We are actively engaging with academia, particularly through the Defence Academy and RUSI and the Chairman gave a speech at RUSI’s Defence Acquisition Conference last week.

This is a rolling programme of engagement – please do contact me, or visit the SSRO stand here at the conference if you would like to find out more.

Our first year has been challenging and busy, yet extremely productive. I thought I’d provide an overview of what we have achieved.

One of our first tasks was to establish the SSRO. This included establishing governance arrangements through implementing a working Board and its sub committees.

Our next challenge was to set up our office in London, and implement the necessary security measures and IT infrastructure.

We then set about engaging our stakeholders and establishing ourselves as a robust and credible organisation.

We had a whole range of information that needed to be communicated – statutory guidance, reporting templates and consultations.

During our engagement we are always keen to hear where the regulations may need to be clarified.

As I mentioned in a previous slide, we have also issued guidance on allowable costs, through which we expect significant cost savings to be realised. We hope this will encourage greater efficiency to the benefit of everyone.

All of our preparation has been put into practical use for the four QDCs we are currently working on.

On top of this we have the consultation and review of the baseline profit rate and preparing the first annual compliance report.

Having marked our first anniversary in July, I can say that the structure and theory has been well established: we are now firmly in operational mode.

Continuing my reflection as to what we have found from our first year, there are two good examples of how we are working to make the framework a success.

First, we are flexible and are learning to move within the regulations. For example, we were told by stakeholders that the process for dealing with opinions was too long. As a result we revisited what we had in place and shortened the process.

Secondly, we are aware that operating within the framework represents a new way of doing things. In handling qualifying defence contracts we have engaged with the relevant companies to help them complete the process.

We are helpful and open.

An important step in achieving success is to build public confidence in a credible single source contracting model that saves time and tender costs.

When used appropriately, single source contracting can lead to reductions in the cost and length of the procurement process - delivering capability to the frontline more quickly and for the right price. Governance by credible regulation will provide assurance that value for money is being obtained by the taxpayer and we are sustaining our industrial defence sector.

Having met with a range of stakeholders, one of the most regular questions I’m asked is – ‘how will you know you’re doing well?’ So I thought I’d outline what I see as success for the SSRO.

We’d like to:

  • Increase understanding of the SSRO and our role as the independent, external regulator of the single source contract regulations regime
  • Maintain our independence
  • Manage an unpredictable workload and always being ready to receive referrals
  • Ensure the compliance report is fair and promotes compliance with the Regulations by MOD and industry

The most important criteria of judging our success is whether single source defence procurement is held as a credible acquisition alternative, where competitive procurement is simply not appropriate.

I appreciate that was a very quick canter through the SSRO, our functions and our work, but I’m happy to take questions from you now.