Approximately 40 per cent of all UK Ministry of Defence (MOD) procurement is bought without competition. Under the current 'Yellow Book' arrangements, the defence industry works to a reduced fixed margin, does not pay for the cost of overheads and, accordingly, sees little direct financial benefit from reducing costs.
Lord Currie’s review of the Yellow Book rules presents a potential step change in the UK MOD's approach to single source procurement and the opportunity to drive cost efficiencies and transform the relationship between the MOD and industry.
By better aligning commercial incentives, working with the MOD to embrace cost transparency and focusing investment on capability delivery and skills retention, the defence industry can transform operations and position itself for a more sustainable future.
Establish contractual arrangements that provide real incentives and promote sustainability
Lord Currie recommends removing current caps on profit margins giving suppliers a real incentive to cut costs and share savings with the MOD. Lord Currie proposes a 50/50 sharing of benefit as the default; this means that a 20 per cent cut in fixed costs shared 50/50 between the industry supplier and the MOD could both double profit margins for the supplier and save the MOD money – and, by reducing costs, potentially increase the sustainability of the platform.
To achieve cost reductions, suppliers should negotiate incentives with the MOD and pursue them enthusiastically. If industry is confident that it can generate savings and that the MOD will not re-baseline costs, these arrangements can offer profit growth and future sustainability despite reduced revenue and cost base.
Embrace cost transparency
Another key recommendation of the Yellow Book review is to move to a common approach to cost transparency. This will enable the MOD to understand and question how money is spent and to see how this changes over time. Cost transparency is partially a quid pro quo for the improved incentives, and part of increasing trust between the MOD and its suppliers.
Cost transparency can also help drive down total (MOD and industry) costs if it is extended both ways. One of the challenges in reducing costs historically has been the lack of a clear view of current costs (and their levers and drivers), making it difficult to make the case for change and measure savings. Greater transparency will highlight duplication and inefficiency and drive total costs down further and faster. It will also enable the MOD to understand how spend in one area can deliver bigger savings in another so increasing the scope and value of opportunities that can be pursued.
Ensure limited funding is directed at delivering current and future military capability and sustaining critical skills
With the equipment budget under such severe pressure, further programme cuts and redundancies are expected across the UK defence sector. Industry should ensure that existing funding is invested to create long-term value for the business, rather than to sustain a high cost base for short-term return. Funding must be directed at maintaining critical technical skills and developing future technology, equipment and intellectual property that may be exploited at home and in the export market, sustaining it into the future.
PA Consulting Group works with the UK MOD and defence industry companies to reduce costs, improve commercial arrangements, win business and exploit technology. For example, we helped the UK MOD to reduce the cost of surface ship support by 20 per cent and worked with BAE Systems (Platform Solutions) to identify bought-in cost savings of over 10 per cent and improve the performance of the supply chain .
To find out more about how PA’s work in defence transformation or to speak to one or our experts about creating efficiencies for the UK MOD and industry, please contact us now.