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JOINT STANDING COMMITTEE ON FOREIGN AFFAIRS, DEFENCE AND TRADE - 10/07/2008 - Department of Defence annual report 2006-07

CHAIR —Although the subcommittee does not require you to give evidence on oath, I should advise that these hearings are legal proceedings of the parliament and therefore have the same standing as proceedings of the respective Houses. Do you wish to make any opening statements to the committee?

Dr Gumley —No. We would invite questions. I understand we have a very full agenda of questions to be asked, so it might be best if we just move to what the committee would like to ask.

CHAIR —I should probably note that on previous occasions it has been customary for the Chief of Defence and the service chiefs to attend hearings of this sort and there may well be matters that we will want to pursue that would be better directed to them. Should that be the case, we will arrange a further session at which the relevant chiefs and CDF will be able to attend. I will commence by making a comment and a question. In the annual report on those top 30 projects there are a number in which the budgeted estimate, which was included in the May 2006 budget, is hugely out of kilter with the final amount paid, the actual expenditure in 2006-07. The parliament and the public have a pretty fair expectation that when budgets are adopted the expenditure mirrors as closely as possible what transpires. This is not an isolated incident. This is not the first year we have seen annual reports where these things happen. I would invite your comment as to why there are so many significant variations. I would be happy to go through a number of particular examples if you wish. You might have some general comments before we start talking about specifics or you might want to run through them yourselves.

Dr Gumley —The biggest problem we are facing in Defence equipment acquisition is schedule. As we have benchmarked ourselves against other countries and as we have looked at our own performance, we find that, once you make corrections for foreign exchange, inflation, changes of quantity and transfers to other parts of the Defence organisation, that post second pass or post contract formation we are bringing in most of the projects at/or around the budget. In other words, cost is not the thing that gives us deep concern. The statistics we have are that in 239 major projects—and we define a major project as over $20 million—closed over the last 10 years with an accumulated value of $27 billion, when you make those corrections for foreign exchange, inflation, quantities and transfers they came in on average at 98 per cent of the budget. That is a surprise to many people. When you look at the data it shows that about 20 per cent of the projects go over in cost, about 20 per cent of the projects come in or around the budget, and about 60 per cent actually come in under. Those that come in under pretty much pay for those that come in over after you make those corrections for the quantities. I would point out that this is post second pass approval when we are into actually building or delivering the equipment.

Where cost has a difficulty in the whole Defence acquisition space is usually in the period before second pass when people are still working out and defining what they want. As Mark Thomson from ASPI has shown in his budget briefs, which he puts out every year—and he does a deep analysis of this—the typical change in costs between the time it is in the Defence capability plan and when it gets to second pass approval are in the order of 60 or 70 per cent. That data is very similar to what the Americans and the British are finding. Around the English-speaking Western countries there seems to be quite a lot of similarity in how the Defence projects are running. The cost problem is primarily up to second pass. I am not saying we do not have a few costly projects afterwards, but primarily the pattern is estimating up to second pass.

That leads us to what I think is the major problem with Defence acquisitions, and that is schedule—in other words, delivering the projects on time. Typically the more complex the weapons system, the greater the project delays. Most of our major projects run two or three years late. We have been doing quite a bit of analysis on the causes of those schedule delays. Perhaps as the questioning develops from the committee I might be able to expand on some of the reasons we have the schedule problems.

So, how does that get back to your direct question? We pay contractors only when they put in an invoice for goods and services correctly rendered. If the invoices do not come in, we do not pay. Most of the invoices come in either through an earned value payment, which is an assessment of how much work has actually been done, or by meeting particular contract milestones. If those milestones are not met, there is no invoice, therefore there is no cash payment and therefore it shows up in the annual report and in the PBS as an underspend. So, a fairly accurate surrogate for schedule delay, which is measured in months, is actually the cash underspend that you are finding in the PBS and in the annual report.

CHAIR —I just want to make sure that I understand correctly the position you have described. The schedule delays that are occurring are roughly in line with other high-tech defence forces? We therefore have some expectation that we may encounter some degree of slippage in programs. Therefore, does that in any way get factored into the budget estimate?

Dr Gumley —When the budget estimates were done in 2006 each project was asked to report their cash needs and they made the assumption that the contractor would meet the milestones as written in the contract. That is the cash estimates. If there are any delays they will show up as cash underspends.

CHAIR —We budget on the basis that it will be done on schedule, but we know from past experience and comparisons with advanced defence forces that a significant percentage of them will not be done on schedule.

Dr Gumley —Yes. What we then do is over-program by about 15 per cent, so we make an assumption that in any one year about 15 per cent of the milestones in cash terms will be slipped and so when we put a final amount into the budget it is worked out project by project. Over 200 projects are looked at, they are all added up, and then we make a management decision to put about 85 per cent of those total milestone payments into the PBS. If schedule slippage is greater than about 15 per cent it will show up as an underspend in the book, and over the last few years it has been running a bit higher than 15 per cent.

Senator FORSHAW —It has been running—

Dr Gumley —A bit higher than 15 per cent. That is how you get the schedule slippage or the cash underspend between the PBS and what is the actual result for the year.

CHAIR —I would like to go to some specifics in the DMO annual report, table 3.2, page 22. With the Tiger helicopter we budgeted $312 million. We ended up spending about half of that. In fact even the revised estimate was well above what was actually spent. I would have to say that in the normal course of events I do not take too much notice of the revised estimate because I figure that, if you cannot get that one close to the mark something is really wrong. But there is an example where the revised estimate was still well out of kilter. Can someone explain why that is?

Dr Gumley —I have a group of the project experts here from DMO and I invite them to talk to their individual projects as you raise them.

Major Gen. Fraser —The Tiger underachievement is attributed to two factors. The first is the contractor not making what was contracted, not achieving what we expected to be contracted. The second and major one specifically for Tiger was that we suspended payment to Australian Aerospace, the prime contractor, when it failed to achieve a stop-payment milestone. It was in the contract provisions and we took the quite significant step of ceasing payments to it until it achieves the required performance outcomes. Nearly for the whole financial year it was not paid for work conducted on the aircraft and on the project. It continues to provide services and deliver equipment but it was not being paid for that. That is an important issue, because otherwise the project would continue to delay even further still. In the Tiger case we have negotiated a successful outcome to what then became a dispute over those issues and the through-life support, and we have resumed partial payment to it at the moment, withholding some of it until we actually sign the contract change proposal.

CHAIR —Where would you say things are up to at the moment?

Major Gen. Fraser —Since negotiating a successful outcome through the dispute, the program has gained significant momentum. The aircraft in Australia has flown 2,700 hours, 24 personnel have trained, and the aircraft have been deployed to Darwin as of a week ago, at the end of June, importantly, into the regiment and into the operational capability to start that work. Importantly for us, the negotiation converted the through-life support contract from essentially what was a cost-plus type contract to a performance based contract, driving an incentive on the contractor therefore to reduce the total cost of ownership to the Commonwealth. It has also focused on delivering an operational capability to Army as quickly as we can possibly do so. I am very pleased with the new Australian Aerospace chief executive officer’s work and the focus of the company to provide us that capability.

CHAIR —Was the Tiger’s original contract a cost-plus contract?

Major Gen. Fraser —Part of it was in the through-life support element of it.

CHAIR —Is that now performance based?

Major Gen. Fraser —That is correct. That is now performance based.

CHAIR —Do we normally enter into cost-plus contracts?

Major Gen. Fraser —I will let the CEO perhaps answer that, but many of the earlier contracts were based on that scenario. Of course over about the last four to five years there has been more performance based contracting.

Mr ROBERT —The annual report lists a 24-month slippage primarily because of delays in the Franco-German program on which the Tiger relies for certification and qualification. What actually slipped in the Franco-German program that impacted us by 24 months?

Major Gen. Fraser —The Franco-German program itself was unable to achieve its schedule, and there were two aspects for our program. The first was training the instructor staff, who were going to be trained in France. The first four instructors were to be trained on their aircraft. Because the French army had not accepted their aircraft and the French equivalent to DMO had not accepted their aircraft, we were unable to effect that training in the time frame that we envisaged and was contracted. The second was that much of the data from their aircraft was to be used for our simulator—for example, to assist us with the certification and the development of the simulator. The result of that was a two-year schedule slip in the training of our staff and training of the initial cadre of flight crew.

Mr ROBERT —Were there any other options on the table for that training?

Major Gen. Fraser —No, there are not. We managed as best as we possibly could to recover training, but there are no other Tigers in service in the world at this point in time. We did send some personnel across to fly with the US. We have looked at lead-in skills, and part of the resulted negotiations here is to put two EC135s into Darwin glass cockpit aircraft to compress the training on the aircraft type as much as we possibly can. We have deployed some instructors across to France to train with the French army to catch up as best we possibly can. But realistically I do not see that we will recover the two years. Our focus now is on developing the operational capability as quickly as we can. We cannot recover those first two years of basic training. Perhaps we might be able to recover some schedule in the operational transition and development of the operational capability, which is what our focus is on.

Mr ROBERT —At a project management plan level, considering we decided to go with a platform that was not developed compared with a platform that actually was in service across the world in the form of the Apache or other platforms, what did we put down on our risk matrix with respect to possible slippages through training or other areas since the platform had not actually been developed?

Major Gen. Fraser —The Franco-German program was 18 months ahead of us at that point in time when we signed the contract and there was certainly some risk associated with that. My understanding is that that was an informed risk and we were advised at the time of a reasonable risk mitigator.

I would have to say the French equivalent to DMO has been exceptional for us. We would be a lot further behind had it not provided us the support it has done. It has taken the engineering and certification work for the aircraft and in isolation has advanced us. There was a period of time when our aircraft had caught up that full 18 months to the Franco-German program as far as certification goes. We had not completed the training but we had certainly caught up in all the certification work. It is a risk.

The Tiger aircraft is an excellent aircraft. It is an outstanding aircraft. We have exchange personnel from the US who fly Apache and fly Cobra, who are flying with us. It will be an excellent aircraft. But you are right in your inference there that there was risk in an early developmental program. Perhaps part of many of the lessons learned—and I know the chair is going to ask us about Seasprite later on—is the full understanding of the maturity level of the product and the off-the-shelf level of the product that we are trying to gain for the Defence Force and to introduce into service to make an informed decision. It does not mean we should not take some risk, because in some cases we do need to take some risk with the developmental program. It just needs to be understood that we have that risk and therefore there is potential delay to the operational capability.

Mr ROBERT —Going back to the risk matrix at the start of the project, what was the risk mitigator that was put as an offset to slippages in training and those factors?

Major Gen. Fraser —Specifically there was no offset risk to training of instructors. The only way that we could do that was that we were reliant upon the Franco-German program for the initial training of the aircrew. What we ended up doing was migrating it to Australia, and the company at its own expense migrated its senior instructor to Australia one-on-one for our personnel. So that was the risk mitigation that was implemented to be able to do that, and that compressed some of the training.

Mr ROBERT —Considering the CEO’s comment before that our majors are running two to three years late, and that the efficiency of our DMO is of the same standard as the efficiency of other Western countries, we would have had to expect, at the start of the Tiger helicopter program, albeit it was 18 months ahead, that they would slip by two to three years, as is indicated with major projects currently around the world. What did we have to mitigate a slippage of that order?

Major Gen. Fraser —Our Tiger program is as good as any as far as schedule goes. There are others that have suffered far more delay than we have. If we take the MRH-90 program—and it is important for us to take the lessons from what we have done—for both the contractor and ourselves, the Australian MRH-90 program is the only one in the world at the moment that is on schedule. It is a tight schedule and difficult, but those lessons have been applied.

Dr Gumley —To clarify my comment about two to three years, it is important to differentiate between development projects, which are typically running at two to three years, and when you are buying truly military off the shelf. For example, the Super Hornets, which are truly off the shelf and are coming out of the Boeing production line, are right on schedule at the moment.

Mr ROBERT —On the two to three years for development projects, considering we have now a great body of lessons learnt, what are we doing differently in DMO now as a result of the lessons learnt of slippage on development projects?

Dr Gumley —This has been the benefit of the Kinnaird two-pass process. What Kinnaird got right back in 2003, and we have been implementing it ever since, is that a lot more work needs to be done between first and second pass on analysing risks, reducing risks, and working out risk mitigators so that you do not end up with these sorts of problems. Now we typically spend five per cent or even as high as 10 per cent of a project’s work prior second pass. The high percentage applies to the smaller projects and the big projects are perhaps around about the five per cent or a bit less. We do a lot of work on risk mitigation before we actually go to contract. The advantage of that is that when you actually do go to contract there is a much greater chance, from DMO’s perspective but also from the contractor’s perspective, that people do not sign up to aspirational goals and things that just cannot be delivered.

CHAIR —You touched on the MRH-90 and you partly answered the question that I was going to ask, given that we have the same contractor providing both helicopter platforms. You mentioned that we are on schedule with the Troop Lift Helicopter. Are there improvements that we have picked up from the Tiger project that we have just been talking about that have fed into that Troop Lift Helicopter that have enabled us to keep on track and, if there are, are there any wider lessons we can learn for other acquisitions?

Major Gen. Fraser —As much as anything it is about the shared understanding and relationship management between any contractor and any of the project officers. Importantly for Eurocopter, the parent company, and Australian Aerospace, they understand the Commonwealth’s governance requirements. The standards we set and our expectations for documentation and governance requirements are as rigid and robust as any in the world. I do not think that they were as well understood as they might have been in that shared relationship when the first contract was signed for Tiger. Those lessons have been migrated across to MRH-90 and understood. Therefore, for work that needs to be done and appropriately resourced, the contractor resources those areas that are needed to make schedule.

The aircraft, and additionally for MRH-90, is at a more mature state than Tiger was for at stage of the program. Fourteen countries have signed up for MRH-90, with about 550 aircraft on order, and there are more ahead of us that have accepted the aircraft and therefore the aircraft is at a more mature state than the Tiger is, and as we have indicated, which is more developmental in its cycle.

CHAIR —Do we have any cost-plus contract arrangements for the MRH-90?

Major Gen. Fraser —No, we do not.

CHAIR —That is a good thing. While we are talking about helicopters and while you are at the table it might be appropriate if we have a brief look at the Seasprite.

Major Gen. Fraser —Certainly.

CHAIR —How did we get ourselves into a situation where we could spend so much money and go for so long to get a product that is demonstrably not what is required?

Major Gen. Fraser —First of all, I acknowledge the seriousness of this project and the point that we go to, where we would cancel so far down the track a project of this significance, and the amount of funding that government could have used for other areas. I will preface my comments on the point that we are at and the state that we are at with the project. It is still a sensitive issue for us. I am not trying to shirk disclosing information to the committee, and I am more than happy to go in camera or provide significant detailed information. We have reached a mutually agreed outcome with Kaman on the cancellation of the program, which is subject to US government approval. We have requested that US government approval, but it is in process at the moment and has not yet been provided. The objective is for Kaman to take the aircraft and equipment back, sell it on the open market and provide a share of profits back to the Commonwealth, which is at least 50 per cent and at an increasing level.

Part of the deed of negotiation and what we have agreed—and this is in our interests—is that we will not talk down the aircraft unnecessarily. I am not going to shy away from the lessons learned and appropriate to DMO, but it is a difficult stage for us. If it might help the committee and people asking, ‘Where are the lessons?’, the National Audit Office is also conducting an audit and expecting to table its report late in the year, as I understand it, so that will be certainly quite difficult. You have seen some of the media interest in those looking for answers on how we got to this position.

The gate review process that the CEO indicated earlier is an important one. It is on public record that the Seasprite was being procured for a particular size ship. That project was then cancelled. It was not pursued. To me that would be an appropriate gate review point to determine as to whether the project would or would not have been continued.

CHAIR —I appreciate there are some sensitivities and it may be that at a point in time we will want to go into more detail in a private meeting. I certainly do not want to in any way have today’s proceedings interfere with or jeopardise any of that. Obviously the public and the parliament want to be confident that taxpayers’ dollars are going to produce desired outcomes. You have touched on a part of it, but what are we doing differently today in acquisition that would avoid making a similar mistake or are we still open to revisit a mistake? This is not a reflection on the platform; it is a question of square pegs for square holes. How do we ensure that next year or the year after we are not going to have another parliamentary committee asking similar questions about another project? What are we doing now that is going to prevent that happening?

Dr Gumley —Essentially it is a lot more risk mitigation prior to entering contract. The time to bail out of a project is early, and from time to time we will make recommendations to government that a project is simply too risky and we should bail out. I think the public would understand if you spent two per cent or three per cent of the project and bail then rather than wait till you have spent 95 per cent of the project. Sometimes we will just have to make that hard call if something is not going to work or is excessively risky. That requires you to do a lot more engineering, contract, legal and other analysis up front, and that is what we are attempting to do now.

Senator MARK BISHOP —General Fraser, I think you said that there had been a mutually agreed cancellation process that was subject to US government approval, and my memory is that Dr Gumley has told us elsewhere that the Australian government is likely to realise something in the order of $40 million or $50 million when the eventual product is broken up and sold off. Are those three points correct?

Major Gen. Fraser —What we have agreed is a minimum amount, regardless of whether the aircraft are sold by Kaman or not, and that is the $39.5 million. Plus, there is an additional $30 million that we have retained for spares and transferred them out of the Seasprite program across to Sea Hawk and some to Black Hawk. It is our expectation that we will gain far more than that. I cannot put a figure on that at the moment. The market will tell us what that figure is, and any actions that we take between now and when the aircraft are sold will clearly affect whatever the return is back to the Commonwealth. It is our expectation, though, that we will gain more than that.

Senator MARK BISHOP —That is the point I wanted to address. The chair is very charitable. I have sat through about 27 of those identical explanations over the last 10 years and it comes down to this: when a project goes astray there has never been full and adequate disclosure of the reasons. I hear you saying now, some two months after the government has chosen to wrap it up, you are engaged in negotiations and, until the negotiation process is concluded, we are not to be provided with any detail. The argument you put is it is commercial-in-confidence, it is a mutually agreed cancellation clause in the contract, but we have spent close to $1 billion on this project through successive governments and repeatedly in public forums we have been assured by yourself and other responsible officers over the last 10 years that it is on track, the problems are in the past, the money that has been spent has been worth while and the project will deliver. But even now, two months after this, we cannot be told why it went wrong or how it went wrong because it might impinge on $30-something million to come some time perhaps in the future. That whole process strikes me as being unsatisfactory and goes to the heart of the issues that you and I and others have been discussing for the last 10 years. When are we going to get on time, full disclosure of the detail of projects, as opposed to having this argy-bargy in numerous committees year in, year out? With due respect, it is just not good enough, to the previous government and certainly this government.

Major Gen. Fraser —I understand your position and I do not believe that it has ever been my position that the project is going well.

Senator MARK BISHOP —By ‘you’ I refer generally to the powers that be.

Major Gen. Fraser —I accept your position. We have spent $1.1 billion of taxpayers’ money that government could have spent on other areas. It is not deliberate that the people who have been involved since day one have stepped away from it. In capability they have made compromises, concessions, both by the contractor and ourselves, to try to deliver a capability as soon as they could to Navy. In normal commercial contracts you have liquidated damages, some sort of recompense that is a return back to the shareholder. That is not easy but a far easier solution and result rather than what we are trying to do. There is no capability in lieu for Seasprite and so along the way they have attempted, by changes, try to make variations to deliver a capability. It is the cumulative effects of those that have caused the problem. Each one in isolation over many years might have been acceptable to bring the aircraft through to fruition, but they have not been able to step back and look at the collective effects as time has moved on. The contemporary expectations for airworthiness as a result of two major accidents, being the Sea King and its board of inquiry and the Black Hawk board of inquiry, and the community expectations have changed. I am more than happy to go into full disclosure with you in an in camera session to start with.

Senator MARK BISHOP —The others might want to have it in camera. I would prefer to have the lessons learnt in public, openly discussed and explained, not in some secret committee whereby half a dozen men or women are given some information. That is the point. There has not been sufficient, adequate disclosure. On your first point, yes, there has been incremental change year in, year out, additions, scope change, and community expectations can change. But every four months for the last seven years this project has been examined in detail by me and others and every four months we have been told they are minor problems that can be accommodated and solved and that this is the last change. Now you tell me at the end the quantum of changes, the quantum of variations, the aggregate was so great that it could not be done, but that only came after we spent $1.1 billion. That is the point I am trying to hammer home.

Major Gen. Fraser —Your point is quite valid and I am not trying to shy away from it. The gate review process and the appropriate external scrutiny of the project is a critical lesson for us. Does DMO now have that? We are about to introduce a further gate review system. The multipass process in the first place back to government provides government a far greater degree of scrutiny and control than what we previously have had.

CHAIR —Dr Gumley is seeking to make a contribution.

Dr Gumley —Yes. The Kinnaird process takes a good chunk of the risk out, but we need to do more. Mr Gillis can talk about the gate review process that we are introducing now based on lessons learnt from things like Seasprite. You cannot sit around and have a Seasprite happen and not think about how you would stop that happening again.

Mr Gillis —There are lessons that we have picked up out of a range of projects over the last couple of years, and especially post the implementation of Kinnaird. Kinnaird is an excellent system of providing government with a clear insight, a pre-first pass and second pass, but what had not happened in the past was a detailed executive review at particular critical times in the project. When we got to a point where it was clear that a project should be cancelled or it was clear that a project was going to fail or it needed to have some sort of executive intervention there was not a structured approach to actually doing that analysis. Now we have implemented that process. We will have a series of gates. It is very similar to the process that the large industry organisations do with their major projects. So it will be at a stage of pre-first pass, pre-second pass, at pre-contract signature, to make sure we understand it exactly, and even after we have gone to government at second pass, we have gone through the National Security Committee of cabinet and we have got government agreement, post that there is a period of negotiations that occur with a contractor. So before we sign up to a contract we have an executive review, and for those larger programs, the ACATIs and IIs, that will conducted by me, the CEO and the general manager of programs—all experienced program managers who have managed multibillion-dollar programs in the past. So there is a process.

Also, one of the other critical ones is that we are going to conduct a gate review at 20 per cent of life cycle. Twenty per cent of life cycle in any project is usually the indicator that, if you look at the scheduled performance indicator or the cost performance indicators at that, it will tell you whether the project is going to pass or fail its life. The first assumption at that gate will be: is this project going to succeed or not? If it is not going to succeed, that is the point at which we advise government that it is not worth spending any more money on it.

CHAIR —What do you mean by 20 per cent of life cycle?

Mr Gillis —A project is going to run for eight years and we go into it at the end of the first year or two. It is a project management principle. If you analyse a project at about 20 per cent of life cycle you use its performance indicators and extrapolate those out through life, it will give you an outcome as to whether something is actually going to achieve its schedule or its budget. We then have to go back to the capability managers and to the services to say: ‘Is this capability actually going to be delivering on schedule that is going to meet your requirements? Are there technical issues and are there cost issues there that we need to be aware of?’

CHAIR —So 20 per cent of life cycle is after acquisition?

Mr Gillis —It is after acquisition.

CHAIR —Is it not too late then?

Mr Gillis —No. This is a series of gates, at contract signature and at 20 per cent of the acquisitions cycle. For an eight-year program it is at the end of the second year.

Senator FORSHAW —You might have just answered my question. Earlier, in response to the chair’s question about what lessons have been learned and how are we going to avoid this in the future, Dr Gumley said that you are building in these risk mitigation factors. Are these gate processes what you are talking about as being the new risk mitigation steps?

Mr Gillis —It is also making sure that you do a really detailed analysis at those particular stages in the life of a project to ensure that you are getting that executive oversight and ensuring that you are actually testing to see whether something should be going or not, and the assumption should be at those stages if in fact there is something that is going to fail we declare it early and quickly to government, and we provide government and our stakeholders, the service chiefs, with that advice.

Senator FORSHAW —I was going to ask you to flesh that out a bit, but you have just done that. The other part of my question is: what are you doing about the actual contractual arrangements? I have not been asking questions on this like Senator Bishop has for seven years, but let me assure you I have been hearing about it for seven years. What I am getting at is that it seems to me that, if there were deficiencies in the actual contractual arrangements that were being entered into—and you might comment if there were any—which would enable you to apply more pressure or withhold payments, you may have picked up on some of those issues. You said, for instance, in the Tiger one you have gone to a performance rather than a cost-plus. Is much focus being directed at ultimately what the contractual arrangements are that you enter into so that you can get out of these things easier or quicker if the need arises and at a less cost than we have just had with Seasprite? Do you understand what I am saying? I am talking about the technical and legal aspects as distinct from assessing the performance at its various benchmarks.

Dr Gumley —Absolutely. The contracts are absolutely critical. There are a few realities, though, about the overall international defence contracting space that probably need to be stated.

Senator FORSHAW —I thought you would probably go to that.

Dr Gumley —The first thing is that in many of the contracts, no matter how good the contract is, the Commonwealth ends up holding most of the risk anyway. I will give you an example. If you are building $8 billion of air warfare destroyers and you have companies whose market capitalisation might be measured in several hundreds of millions of dollars, how much has to go wrong before you bankrupt the company and you are left with half-built ships sitting on the dock? And who is going to finish them? So, it depends on who you are contracting with and how much risk they can manage. The first five per cent or 10 per cent of an overall project risk can probably be offloaded to a company through a contract, but you get to a stage where there is a mismatch between the magnitude of the dollars and the size of the business doing the work. Then you look at the companies that are bigger than the Australian Defence Force. Who has got the power and the game when you are dealing with, say, Boeing, which has 170,000 people, or Lockheed Martin or other really big companies who have the only piece of equipment that is suitable? We do our very best to get the best contractual terms, but no-one should ever be left with the view that the Commonwealth is able to offload all of the risk to the contractor.

The corollary of all that is that you need a commercially savvy, strong and intervening Defence Materiel Organisation, or the equivalent in other countries, to manage the buyer’s risks intensively rather than just think you can just pay $100 and buy a widget. It does not work that way. To manage what I call that massive amount of residual risk that always stays with the Commonwealth, what DMO is doing is building up the professionalism of our staff in contracting, engineering and program management. Only by having a cadre of about 2,000 experienced professional people are we really going to be able to manage the risk properly for the Commonwealth. This is a program that we started four or five years ago, and we are working at it very intensively. How many program managers do we have now, Mr Gillis?

Mr Gillis —Over 400.

Dr Gumley —We have gone from having no or very few qualified program managers four years ago to having over 400. We have graduated 400 qualified program managers in courses and in practical work over the last four years. The only way we are going to be able to reduce the Commonwealth’s risks on these big projects is by having really good people inside the DMO.

Mr Gillis —We are leading the world in the development of training for very high-end project managers. We have developed with the Queensland University of Technology the first ever advanced executive masters program in complex project management, which is now the world leader. That was as a result of one of the lessons learnt, which was that managing these very high-end projects is a very high level skill. You need very special people to run those types of programs. We need to make sure that we train them as best we possibly can. These people are dealing in billions of dollars of taxpayers’ money and we need to make sure that we have the best possible people running those particular jobs.

Mr ROBERT —What will be the impact of the billion dollars worth of savings that the government is looking at from the Department of Defence? I am making an assumption that you must contribute to that.

Dr Gumley —I have offered five per cent savings across the DMO sustainment budget.

Mr ROBERT —What is that total budget?

Dr Gumley —That budget is about $4.5 billion, so I think we offered up about $230 million as savings. My rationale there is that every so often you can have a look at an industry structure in a country and you can work out ways that you can do things better. I reached the view that we had got to that stage in the sustainment world. I wrote to the chief executives and talked to them, and most of the chief executives have either rung me back or talked to me and said, ‘Yes, we want to be with you and make these savings happen through productivity improvements and improving the way we do things.’ So, in a cooperative approach with industry, we will get the five per cent in the sustainment area. On the service fee area, which is what pays for our program managers and engineers, we will do a lot of internal housekeeping to get the five per cent there. There are the standard issues: less travel and better process and so on.

The area that might be of interest to the committee is the acquisition area. How do you get five per cent off our acquisition budget, which is somewhere between $4 billion and $5 billion? To make that happen we need to make some structural changes in how we do some of our acquisitions. For example, buying more military off-the-shelf products reduces your risk profile and therefore can reduce the contingencies that you need to write into projects for things that inevitably go wrong. That cash can be returned to government. We have to make some structural changes to the overall acquisition methods if we want to reduce the acquisition budget.

Senator MARK BISHOP —Mr Gillis, you have made reference today, and in the past we have had discussions about these things, to increasing demands on the project managers, the education process and the upgrading of their skills. Hopefully, that will come to pass in due course. Dr Gumley, in your introductory remarks you referred to the need for a commercially strong DMO. Bearing in mind the structural changes that you are partway through implementing within the organisation to give it a more commercial focus, will that have any implications at all for disclosure regimes, reporting to parliamentary committees and the like in the future?

Dr Gumley —No, I do not think it does. It is the taxpayers who are our main stakeholder and we have an obligation to be able to show the taxpayers through the parliamentary processes, such as committees, and the Audit Office that we are spending the money properly. If committees wanted to go deep and meaningfully into individual clauses in contracts that would cause us some difficulty, particularly during the contract formation stage. But I do not think that a more commercially savvy DMO would lead to less scrutiny. You asked earlier about lessons learnt. On the Seasprite, the Audit Office has responded to a request from the parliament to do a detailed lessons learnt audit on the Seasprite. Ms Wolfe can give a couple of comments on that. I do this to indicate that we are not running away from what everyone needs to learn out of what happened with Seasprite.

Ms Wolfe —We have been working with the Audit Office since December on the audit that Dr Gumley refers to. We have in the last couple of weeks been working with them through the final input to five of the 10 issues papers on the Seasprite project. The issues papers are due to be released formally at the end of July. We then have a 28-day period to respond to the matters that have been raised in the issues papers. The papers are to be tabled at this stage at the end of October. A large part of the focus in working with the Audit Office has been around the lessons learnt. It was a very long, very complex project and there is certainly a series of lessons that can be drawn from that project that we can then apply to the reform agenda in DMO.

Dr Gumley —Did we make some mistakes on the Seasprite? Yes, and we would be pleased to discuss those as the Audit Office helps us through that learning process. I understand there is a Senate estimates round at the end of October. Ms Wolfe, does the report come out before then or not?

Ms Wolfe —It will be fairly close to that, yes. The issues papers that we are focussed on currently with the ANAO are project management, the design acceptance process, the certification process and the advice that goes with the certification process. They are fairly germane to the lessons learnt that can be applied back into DMO. The papers that have been prepared and put together are quite lengthy and quite detailed.

CHAIR —I suspect not every report the Audit Office does is read from cover to cover, but I can assure you this one will be by many.

Ms Wolfe —Yes. We have been working with them very closely since the beginning of December to make sure that it is as accurate and complete as possible.

Mr ROBERT —General Fraser, I would like to go back to the MRH-90. On page 29 of DMO’s annual report there is a section looking at key risks. The second one is delays to indigenous training. Cognisant of the fact that the development of the MRH-90 is far more advanced, there are 14 countries involved and there are 550 aircraft on order, have we had any of these aircraft delivered yet? There are four set for 2008, I believe.

Major Gen. Fraser —Yes. The first two aircraft were accepted on 18 December last year. The flying rate for this first half of the year is not up to the level that we required. The mitigation that we have effected as a result of that is to advance the delivery of one of the aircraft from France by six months. That was brought out by C-17. The loading trial was completed, and it was delivered two weeks ago. Those aircraft are now flying and the training is well under way. The training in France, unlike for the Tiger, was effected completely and fully. In fact, we overtrained; we completed more training in France than what we had expected to do as part of the risk mitigation. The training will commence here in earnest very shortly.

Mr ROBERT —I am cognisant of the CEO saying that the MRH-90 is on track, on budget and on target. Looking at this key risk of delays to indigenous training, can you update the committee on where that risk is up to? Is it still a medium risk now that you have three—

Major Gen. Fraser —I would consider that still to be a medium risk, because we have only just started the Australian version of the training program. The contractor needs to prove the delivery of equipment. As I indicated earlier, our program is the only one that is close to schedule; it is on schedule. It is a very tight schedule for us to achieve first operational capability for Navy in 2010, which is a first flight at sea. For Army, there is to be a troop of four deployable aircraft in 2011. The schedule to achieve that as a full operational capability is quite tight. I mentioned earlier also that we have been able to the lessons from Tiger across to this project. As to the technologies that are new in this aircraft—such as the helmet mounted sight and display, which are quite new technologies—we have been able to take those lessons from Tiger to help us with our domestic training program.

Mr ROBERT —So we have three platforms, with two delivered in December and one in July? Is that correct?

Major Gen. Fraser —That is correct. And the first Australian assembled aircraft should be delivered by the end of this year.

Mr ROBERT —Do you expect any slippage in the project due to training in this country on the current three platforms?

Major Gen. Fraser —At this point, no. It remains a high risk, but at this point I do not expect the capability to suffer as a result of training. We have some mitigation strategies. Because the programs are more advanced overseas, if ours were to delay we would seek to increase company sponsored training levels overseas, and we have utilised that already.

Mr ROBERT —What options do we have overseas for training?

Major Gen. Fraser —We have spoken about off-the-shelf and maturity. Our aircraft is almost identical to the German aircraft, the troop transport helicopter, and therefore we have a matured training system in Germany that we are able to access, as well as that in the factory; the Eurocopter plant.

Mr ROBERT —How many platforms does Germany have operational?

Major Gen. Fraser —I think it is 14 at this point. I would have to take that on notice. I am sorry, I do not know what the exact number is.

Mr ROBERT —So there are sufficient numbers?

Major Gen. Fraser —There are sufficient numbers. It is far more mature than ours is. They delayed their acceptance until they matured the program, but it is still well ahead of our program.

Mr ROBERT —Do you expect to have all 46 frames in operational service by the end of 2011?

Major Gen. Fraser —No. The first four for Army will be in service by 2011. That is the initial operational capability. All 46 aircrafts should have been delivered by the end of 2014.

CHAIR —There are no more questions on the helicopters. It is clear we are not going to get through the list of items in the allocated time, so we will be coming back for some more discussions. Therefore, I thought I might turn to some of the bigger ticket items. Dr Gumley, you mentioned the difference between, as it were, comparatively small defence companies and those global giants. Let us turn to a project with one of the global giants, the acquiring of the AEWACs aircraft, Project Wedgetail. There is a fairly dramatic variation between budget and actual. It was anticipated in the budget in May that there would be a $439 million expenditure. In actual fact, $58 million was spent. Can you tell us why that variation occurred and where things are at?

Dr Gumley —Project Wedgetail is of considerable concern to us. Air Vice Marshal Deeble is the project manager and is in the best position to give you detail.

Air Vice Marshal Deeble —I came on to the program in June 2006. At that point in time an 18-month delay to the program was declared by Boeing. In the following February of 2007 a further six months delay was declared, bringing the total delay to the program of in the order of 28 months. Just recently, Boeing has declared a 10-month additional delay to the program, which is associated with delivering full operational capability to the aircraft. It intends to deliver an increment in the July 2009 timeframe, which will allow us to commence training. The significant variances in the budget are specifically related to those delays and the failure to achieve milestones on the program, including progress payments, and we have had to slip those out into further years.

Senator MARK BISHOP —What is the current total delay?

Air Vice Marshal Deeble —There are a number of milestones. The total delay to the delivery of the aircraft is 38 months until full operational capability. We will receive and accept aircraft in the July 2009 timeframe based on the current Boeing schedule and will be able to support training in that July 2009 timeframe.

Dr Gumley —Incidentally, a critical lesson learnt here is the importance of the DMO having full visibility of the contractor’s schedule and the contractor being contracted to deliver that schedule to us. It is very hard for us to make estimates of money to be spent if we do not have a fully populated schedule. On Project Wedgetail we waited for that schedule for two years.

Air Vice Marshal Deeble —Yes.

Mr Gillis —Boeing, one of the largest defence contractors in the world and one of the largest aircraft builders in the world, was unable to provide us with a detailed schedule for some two years and we waited. We were making our basis of estimates on our expenditure without clarity of that schedule.

Senator MARK BISHOP —And we had not pinned them down in the original contract or subsequent variations to provide us with that?

Dr Gumley —Contractually they were obligated to deliver us a schedule, but they did not.

CHAIR —Were there any penalties involved in failure?

Dr Gumley —We stopped paying them. We are not going to pay contractors for work they do not do.

Senator MARK BISHOP —Were they doing the work but not providing the schedule?

Dr Gumley —Yes.

Senator MARK BISHOP —So, they were doing the work but not providing the schedule, so you were unable to confirm—

Dr Gumley —We were unable to confirm where they were exactly. You can have a number of people crawling through the plant and looking at the aircraft, but when it comes to software development, radar development and the performance of the subcontractors and so on, you cannot have the full knowledge. You rely on your prime contractor to tell you where they are at and, just as importantly, where they are not at.

Air Vice Marshal Deeble —The significant issues that we are confronting are the developmental issues associated with things like the multirole electronically scanned array MESA radar, and that is an area that is highly technical. We are at the cutting edge. We are the first customer of a first of type, so there are many issues associated with those developmental areas.

Senator MARK BISHOP —We have contracted Boeing to provide a product and a timetable for delivery and there are milestones. Do we have anyone embedded at a senior level with the technical know-how to identify early on apparent non-compliance with contract milestones?

Air Vice Marshal Deeble —We have a resident project team working co-sited with Boeing in Seattle. I also have a small resident team co-sited with Northrop Grumman in Baltimore. They are responsible for the development of the radar. I have a resident team with British Aerospace in Adelaide that provide me with the data and their assessment against schedule and the technical risks that we face on the program. We have a good insight. In some areas, in particular with the radar, we are constrained by technology transfer issues associated with the US, so we do not have full insight into some of those areas where those licensing arrangements with the US constrain us. We engage with US government agencies that provide additional support to us in that regard to provide some level of insight where we do not get through to that technology transfer.

Senator MARK BISHOP —With respect to the series of teams identified by the Air Vice Marshal, are they embedded to the extent such that they can keep you sufficiently informed? Secondly, do they have the level of technical know-how to keep you sufficiently informed about the progress of multibillion-dollar projects instead of you being told irregularly that the project has blown out by another 10 or 12 months?

Dr Gumley —The embedded teams are absolutely critical for us to understand where the contractor is on their project. On Wedgetail, it would be fair to say that we were predicting the delays long before Boeing was acknowledging the delays. We were getting regular reports saying that there were this many milestones being missed and that technical delivery was not going to happen, and we were in a position in which we were informing government this extra delay a good year to a year and a half before it happened. The lesson learnt there is that if you are going to do a major international development program you must have embedded staff if you are going to do it effectively.

Mr Gillis —One of the issues we are finding with both Boeing US and Boeing Australia is a systemic problem with schedule management. We are working with Boeing to assist them to improve how they conduct and draft up their schedules and to provide good schedule analysis, because the same problems in schedule management and delivery of schedule are occurring on Vigilair and HF Modern and a number of other Boeing projects. So we are working with the supplier to assist them in improving their schedule management. Boeing is a very good company in respect to its provision of commercial aircraft, but it is having some problems with its delivery of projects in Australia.

Mr ROBERT —Considering the Air Vice Marshal’s comments on first customer/first of type, we have looked at the helicopters before with respect to again us being the lead country, and you said that there are two to three-year delay on development projects. Should we as a nation be first customer/first of type in what we do and what we procure or should we perhaps be looking at things like the MRH-90, where we are the second customer?

Dr Gumley —The sweet spot is to be just behind the curve. It is no good being right down the back of the queue because you end up with obsolete equipment. The sweet spot is one or two years behind the lead customers.

Mr ROBERT —Which is no different to banking or telecommunications or any other industry in the nation, because of our capitalised size—1.5 per cent of the world’s stock market and so on. Considering that, what is DMO doing to ensure that we are indeed one behind the curve as opposed to first customer/first of type?

Dr Gumley —It is showing up in the risk assessments as we do new projects. A good example of that was the Air Warfare Destroyer decision. There was a competition, effectively, between an evolved ship—which is a nice way of saying a brand-new ship that has never been built before—and an existing ship where you just do the absolutely necessary, but no more than necessary, Australian modifications. When they looked at the risk profile, the government chose the existing ship based on the Spanish F105 as a better place to be, because the Spanish have already built five of them. We were coming in as second customer. There will be some technical problems on the AWD, but there is nowhere near the risk you might have been taking on if you had been lead customer with a ship that had never been built before. The LHD is another example. We are second customer there rather than first customer. That is the big amphibious ship.

Mr Gillis —We have an embedded team of six staff working in Spain watching the construction of the first of the Spanish LHDs, which was launched a couple of months ago. We are learning with the armada about the procurement of their vessel, and one of the things that we are ensuring is that our vessel is as identical to the Spanish vessel as possible. We want as minimal change as possible.

Mr ROBERT —Will you be recommending to government, based on your comments there, that we go with second customer status, that we go with embedding staff within project teams as much as possible, and that first customer/first of type should be a last resort? Is that a fair surmise of what you are leaning towards?

Dr Gumley —There are some technologies for which just from the sheer capability point of view you might want to be right up the front, but my strong preference is not to be that lead customer unless you walk in with your eyes wide open to the risk profile that you are truly taking on. It is very substantial, because not only are you taking on the technological and development risks but the contracting risk as well, because you do not know what you are contracting for. When you are first customer and the thing is just being built, you do not know what you are contracting for. The analogy I like to make is this: if you buy a house, you get a standard real estate transaction and conveyancing contract of about 20 pages. If you buy a unit off a plan of a house that has never been built before, you can have contracts running from 500 to 1,000 pages. Every single thing has to be written down because it has never been built before, and quite often when you buy off the plan you end up with something a bit different than what you thought you were buying. The same applies in other sectors of the economy. It is not just in Defence. When you go first you are taking on very substantial technical and contractual risk.

CHAIR —Boeing works with the defence forces of other Western nations with which we have good relations. From our contacts with those other defence forces, have they also encountered situations where for two years they cannot get a schedule? Or are we the lucky ones?

Air Vice Marshal Deeble —In the context of AEWAC, we do have contact with Turkey, which is the second customer for the AEWAC in the international context. They have had similar issues to us with respect to the schedule for their deliveries of the AEWAC.

Dr Gumley —They are second customers, so they are learning from us.

Air Vice Marshal Deeble —Clearly, they are on the tail of delays associated with the development of the systems that we share in common with their AEWAC aircraft.

Mr ROBERT —The great irony is that the Turkish, being the second customer, will probably have a delivery date on the same day as us with considerably less cost, time and delay.

Air Vice Marshal Deeble —They are converging. There are issues specifically related to the Turkish aircraft. There is Turkish industry engagement, so I would not like to comment on that.

CHAIR —Beyond the AEWAC platform, is this something that Boeing makes a practice of? I find it completely unacceptable and frankly quite surprising that an organisation as big as Boeing think that they can contract with the Australian Defence Force, the Australian government, for the supply of a critically important piece of kit and take two years to provide us with a schedule of work. Under any construction that is just unacceptable. I am trying to get some idea about whether or not this is a practice that Boeing seem to have with other purchasing nations and defence forces or whether there is something peculiar about our platform or whether, like I said, we are just the lucky ones.

Air Vice Marshal Deeble —It is true to say the AEWAC is a very technically complex aircraft. There are some highly developmental elements, the MESA radar in particular. We have modified the electronic support measure system as well. We are integrating that into a new mission system. It is at the cutting edge. It has never been done in a 737 form before, so it is technically complex and that is part of the reason. It is not just the military. If you take the A380 being developed by the Europeans and compare that to the Dreamliner being developed by Boeing, there are similar issues relating to the complexity of the program that make it difficult for them to be able to be definitive with respect to schedule. Technical complexity drives some of those schedule issues, in my mind.

Mr ROBERT —So when Boeing put on a road show for us and fly out a 737 and land it at Fairbairn and lots of us go out there and have a look at it and they tell us how wonderful it is—which I think happened about 18 months ago if my memory serves me correctly—we should not take from that that the platform they showed us or any of the things that they told us were necessarily anything to do with what we were going to get other than the shell? Maybe I should ask Boeing that question and not you.

Air Vice Marshal Deeble —I am thinking that that was a rhetorical question.

Mr ROBERT —Yes, that is a fair comment.

Dr Gumley —Going a little bit further on contractors, the Commonwealth Procurement Guidelines allow you to take past performance into account when awarding new projects. Recently there was a project where Boeing was a nominated subcontractor and we told the contractor that it would be an excessive risk to use Boeing on a similar type of project where they are having difficulty in the other projects, and that contractor is finding an alternative subcontractor to do that project.

Mr ROBERT —Are there any other first customer/first of type projects on the DMO’s project list, especially in the developmental space?

Dr Gumley —Yes, there are a number of them. Perhaps we could check through our records and come back to you.

Mr ROBERT —I am just cognisant that the first customer/first of type development projects that we have looked at have all got monstrous slippages. It might be worthwhile for the committee to have a quiet view of any others.

Mr Gillis —The Armidale class patrol boat was an indigenous, designed in Australia, first of class, never been built, 56-metre vessel delivered on schedule and on budget.

Mr ROBERT —A great result.

Mr Gillis —Yes, a great result. These things depend on the complexity. This is something which is not a complex vessel. It is a civil surveillance vessel and therefore it is a relatively low risk.

Mr ROBERT —Is it built for civilian standards and not built for the military?

Mr Gillis —It is built to civilian standards, whereas you are starting to talk about the first of a class of a particular radar, which have never been built and the physics have never been tested. To revert back to the discussion we had about Boeing, Boeing also has some significant subcontractors with respect to the supply of the radars and mission systems in BAE and Northrop Grumman. Their provision of their schedule data to Boeing also limited Boeing’s ability to provide it to us. I would not want to leave the committee with the impression that it is only Boeing’s issue. A number of major subcontractors were involved in that and, at the best request of Boeing, they were not able to get those detailed data out of their subcontractors. That is one of the issues in subcontractor management for these large primes that we are also working with.

Dr Gumley —Nor should we leave the impression that everything Boeing does is unsuccessful. If you look at the C-17 heavy airlift aircraft, that is a hugely successful project. It came from the end of the production line; four C-17s in service now on time, on budget.

Mr ROBERT —Granted, although that was not a development project; we were, what, the 10th or the 20th customer?

Dr Gumley —No, we were about the third customer, but they had already built about 100 of them for the US Air Force before that.

Mr ROBERT —We were not first customer or first of type?

Dr Gumley —No.

CHAIR —Again, perhaps you can check the details and at some later point give the committee advice if there are other examples.

Dr Gumley —Is the question limited to the top 30 or to all 200 projects?

CHAIR —We will just limit it to the top 30, unless someone specifically wants to go beyond that. In rounding off that discussion about the AEWAC, this is a vital capability that we, as a committee, over many parliaments have been regularly informed of as being essential. Indeed, it has been a stated objective of governments for at least 15 years in published white papers to acquire it. This is going to challenge the record books: at least 15 years, off the top of my head. They managed to put a man on the moon 10 years after JFK said it was a good idea. This is taking a long time to produce what we all understand to be an important capability. Some of those reasons have to do with decisions that governments of both political persuasions made over that 15-year period, but I think there would be many people in the parliament keen to see that program conclude satisfactorily. Because of time, I would like to turn to one other important acquisition, perhaps even more important than the one we have just been talking about, and that is the new air combat capability AIR 6000, the JSF. I have an easy question first. Do we know how much we are likely to be paying per platform for these?

Dr Gumley —Yes, we know approximately. There are a few things that are affecting the pricing and I would like to spend a minute, if I may, taking you through those.

CHAIR —Please.

Dr Gumley —Some time ago I said in jest that there are actually 108 different prices for the JSF out in the marketplace and every one of them is correct. You get to that funny situation because there are different models of the JSF. People are quoting them in 2002 dollars, 2008 dollars and 2014 dollars. There are different people doing the estimating. There are different equipment fits. There is a lot of public confusion about what the price is likely to be. There are foreign exchange effects, of course, because the Australian dollar has changed a lot against the US dollar over the years, and so any answer that we give you on the price is going to be conditioned as to exactly what aircraft we are buying in what year and at what exchange rate. That is the condition. I will give you the number in a moment. The other key item is that unlike civilian aircraft programs where normally the companies have a commercial incentive to get you to buy early to get their production line going and therefore will give early buyers a discount, in military aircraft as they build the production line, under the US way they pay for aircraft, the early aircraft costs you a lot more. Typically, early aircraft can be two or three times the price of aircraft two, three or four years later, coming down what I call the experience curve, as they build up production, knowledge and capacity. The implication of that is that there is actually a commercial incentive for all 11 existing proposed customers of the JSF to rush to the back of the queue, because who would want to be left at the front of the queue spending the extra money buying the early aircraft unless you have an absolutely driving capability need. That quickly leads to destabilisation of the program, because if everybody wants to delay purchasing so they do not buy the expensive early aircraft, the production line never really gets going at the rate that gives you the volume effect that is going to drive down the costs of the JSF.

So, as we hear today and over the next few months, this has become recognised by the US authorities and it has become recognised by the eight foreign governments. We are now looking at how we stabilise the program by getting everybody to make their commitments and everybody pays the same price for the aircraft for, say, the first five years of production. As soon as you can get people to make that commercial decision you then actually reduce the costs for everybody. The alternative of everyone going to the back of the queue is that the fixed costs of the program keep going; they have to be paid by somebody, so every aircraft becomes more expensive. We are in a fairly interesting stage at the moment working with the US authorities to get what is called consortium buy or level pricing, but whatever we want to call it is about getting the same price for each of the first five or six years of production of the aircraft.

Senator MARK BISHOP —So, everyone is in a prisoner’s dilemma?

Dr Gumley —Yes, it is a prisoner’s dilemma. If you all act together everybody saves money. As soon as people start breaking ranks, it costs everybody money, including the person who breaks ranks. The awareness of that is dawning on the buying community and people are working out how to do something about it. So, as an estimate of where I think the pricing is, I would be surprised if we paid more than about $75 million a copy for the aircraft, measured in 2008 dollars and assuming we buy at least 75, or three squadrons. As you are aware, there are proposals for 75 and 100. Whichever quantity we may buy, it is a white paper decision and I will not speculate there, but it is of that order. Even if one were to buy 100, $75 million times 100 is $7.5 billion, which is well within the project’s upper limits of $12 to $14 billion in the DCP at the moment. So as I sit here today, the JSF is affordable. I do not have any significant issues with the cost. When it comes to schedule, are we the first customer? No. If we were to go ahead with the plans that we have been looking at over the last couple of years, we would be buying approximately the 70th aircraft off the production line. We are certainly not the first customer; there would be three or four customers before us, but we would be buying them early enough so that we are actually getting the benefits of their advanced capabilities.

Senator FORSHAW —Why is there such a revelation now? Why are people only coming to understand what you have just outlined? It sounds a bit like a Dutch auction where people deliberately wait back but then some try to get in early. The way that works is that the price can be very high at the start or low at the start. Maybe I am missing something. I am just a bit perplexed. With this sort of project and the sort of money involved, you are saying that prospective purchasers are only now starting to come to understand that they are all better if they keep together rather than go off at different stages. I do not know why people are not aware of that.

Dr Gumley —So why is this program different and why is this late awakening happening?

Senator FORSHAW —Yes.

Dr Gumley —In most of the US military aircraft programs the sole customer has been the US government. In other words, the US government pays all the costs of the program, come what may. So it did not matter; someone has to buy the early aircraft. It is the US government, and it did not matter. What makes this program different is that in this case you have three US customers, the Marines, the Navy and the Air Force, and eight countries, maybe nine and 10 coming. Different countries, as different customers, have different economic decision-making cycles. What has made it different is that it has been a joint international program from the start, and stabilising the program for price is something that people are looking at very seriously now.

Senator FORSHAW —I understand that. Maybe I am too naive on this, but I just wonder why the eight countries would not have understood that at the time they decided to get involved in the first place? Surely they would be thinking that if you get involved in something like this it is clearly in your mind. I would have thought that it is going to reach the point when you are going to make the critical decision as to whether you go through to completion.

Dr Gumley —At the Joint Strike Fighter CEOs conference of July 2007, I recall leading a discussion with the foreign countries, explaining this and pointing out the need for a cooperative buying program to reduce everybody’s costs. At that stage a number of the customers had already worked out that they could get a better deal for themselves at the benefit of other people by delaying but they did not look at the cumulative effect of everybody delaying. So, we pointed out—and let me be very clear about this—in Australia’s case, if we delayed a couple of years and we do not get this consortium buying or level pricing, it is a half a billion dollars extra price tag to our taxpayers. We are not playing with small amounts of money. This is a serious commercial negotiation we have to have.

CHAIR —Reading from a quote about the program:

DOD’s recent plan to reduce test resources in order to pay for development cost overruns adds more risk to the overall JSF program. Midway through development, the program is over cost and behind schedule.

That was evidence given by the Government Accountability Office to the US Armed Services Committee in March this year, just a couple of months ago. How does that impact on us? What is our assessment of that, and how does that fit with the cost analysis that you have just given us?

Dr Gumley —The cost they are referring to relates more to the development costs of the aircraft, and they have gone up. It is likely that each of the customers will be asked to pay a small part of that extra cost. At the moment we are expecting Australia’s contribution, if we are asked to pay, will be less than $1 million per aircraft, so $75 million is not a huge amount. We do agree that the fixed cost or the development costs of the aircraft have gone up, but what we pay will be a relatively small portion of that. On schedule—it would be good for the committee in fact to go to Texas and have a look at the production line.

CHAIR —We can be talked into that.

Dr Gumley —It is extremely impressive. The first half-a-dozen aircraft are rolling down the production line now. It is a highly mechanised plant. I have no problems with the aircraft in my head in schedule, in capability or in manufacturability. The program is going well. There is extensive test and evaluation work going on, and in any development program like JSF there are of course a few delays. Many of the delays are behind us. That is when the aircraft went overweight about three years ago and that put a one- to two-year delay into it, and the GAO is referring to that also. If the government were to go ahead with this program, we are still confident of getting our aircraft late 2013-early 2014 for the first ones.

CHAIR —I am sorry, Mr Gumley, my reading of the report is that the GAO is not referring to those earlier delays at all. It is referring to things like the decision to eliminate two test aircraft, which I understand was driven by concerns in the United States within the program with the actual escalating costs and the time delays, which it says reduced flight tests, revised test verification plans and then went on to state:

Officials from several prominent defense offices found that the plan was too risky because it increases the risks of not finding and fixing design and performance problems until late into production, when it is more expensive and disruptive to do so.

That is not old news. That is evidence a couple of months ago talking about decisions within the program that the GAO says will increase the risk of errors and increase the risk of additional cost later in the program because that early testing is not being done. In fact, the sort of risk mitigation you described before that DMO was doing, which seems to me to make good sense, about that front-end analysis is being shed or reduced in respect of the JSF. Is the GAO wrong?

Dr Gumley —The GAO’s comments have been contested by the program, the contractor and others. It becomes a matter of balance as to how pessimistic or optimistic you are on that. You are absolutely right: if you reduce the number of tests, you increase the risk. That is correct.

CHAIR —They are reducing the tests.

Dr Gumley —Yes. No-one is disputing the two test aircraft will not be built and therefore the tests they were going to do will have to be done on the other aircraft.

CHAIR —And that increases the risk?

Dr Gumley —If you had a bit of ability with the other aircraft to do the tests, they can do the tests.

CHAIR —We are talking about first of type/first buyer.

Dr Gumley —Yes.

CHAIR —This is new technology, so all of those risks that we have spoken about earlier today we know need to be factored into this.

Dr Gumley —Yes.

CHAIR —We now know that the original planned testing program has been modified for reasons of cost and scheduling difficulties that the program has encountered, again increasing the risk, which seems to run counter to the best practice purchasing you described earlier. I would like to read another quote from the same submission to the US House committee. It states:

We do not think the official JSF program cost estimate is reliable when judged against best practice cost-estimating standards used throughout the federal government and industry. Specifically, the program cost estimate is not comprehensive, accurate, well documented, or credible.

I would say that is pretty damning.

Dr Gumley —As I said, our information is that some of those statements are being contested by others.

CHAIR —How have we tested it? We are investing not just a great deal of money but also a great deal of our future national security on this platform, and it is a discussion to have with others from Defence as to whether or not perhaps we are on the right path with all of that. I do not propose to go into any of that with the DMO. But given the critical nature of this capability for Australia’s security, given the fact that I think it is the single largest acquisition the Commonwealth will have made since  Federation, what are we doing to satisfy ourselves about the matters to which I have referred from the GAO?

Dr Gumley —We do have embedded staff in the program.

Group Capt. Thornton —I believe we currently have six military members in the program office. Additionally, we have DSTO members embedded and we also have four members who are operating out of the embassy, two from DSTO and two military members. So, we have an overview that way. As well, the program office response to the GAO report has commissioned an independent assessment of the overall project cost.

CHAIR —Who commissioned that?

Group Capt. Thornton —The JSF project office has commissioned an independent assessment.

Senator MARK BISHOP —The DMO?

Dr Gumley —No, the US.

Group Capt. Thornton —No, The US JSF project office. The results from that should be known by the end of this year, which would be prior to our second pass submission. So, we should have a greater fidelity of information.

Dr Gumley —This is important. We have not gone to second pass approval yet. We are in the phase of risk mitigation.

CHAIR —I will be happy to talk about how Air 6000 has been conducted from day one. I hope to get time to do that but I doubt we will do that today. I would be more than glad to have a look at what has been done about evaluating alternative platforms since Air 6000 was first announced.

Senator MARK BISHOP —On this point, we have done first phase and we are getting up to second phase in the JSF. The government has commissioned a two-part review on the JSF and that has been delivered. Were issues raised by the chair in terms of the fidelity or accuracy of the costs and the dispute between US procurement agencies and the GAO over their part of the two-part review commissioned by the current government?

Dr Gumley —Yes. Neil Orme had a look at the GAO reports as part of his review. As you recall, his second part of the report is still with government for consideration and we cannot talk about its contents.

Senator MARK BISHOP —No, but the first part has been received and actioned by government.

Dr Gumley —Yes.

Senator MARK BISHOP —The second part has been received by government and is still under consideration.

Dr Gumley —It is still under consideration, and Mr Orme had all the documents necessary. He had the GAO reports and all the various documents, so it has all been considered.

Senator MARK BISHOP —Can you just remind me of Mr Orme’s title?

Dr Gumley —He was the chief reviewer for Minister Fitzgibbon’s NACC program review, the air combat capability review.

Senator MARK BISHOP —The part 2 review is a strategic review of the utility of the craft and our need for it. That is a different issue to the issue of the dispute and the costings that the chair is raising.

Dr Gumley —But of course you cannot decouple that from schedule and cost and everything else, because if an aeroplane is going to be very late then you miss your capability need. Mr Orme had to have a look at all of that, and then you have to have a look at affordability, how good the aircraft is and recommendations on how many you might need. These were the sorts of issues that Mr Orme was considering in his capability review.

Senator MARK BISHOP —Is considering or has considered?

Dr Gumley —Has considered. His report has finished. It has been given to the government for the government to consider.

Senator MARK BISHOP —This issue of the huge discrepancy in costs, timelines and the like has been specifically considered and he has come to a conclusion on that?

Dr Gumley —Yes, but I cannot talk about that. I do need to qualify also when I put that figure on the table of not more than A$75 million that that is at a 92c exchange rate.

CHAIR —I am sorry, which exchange rate?

Dr Gumley —About a 92c exchange rate. If the Australian dollar tanked down to 50c, I do not want to be held accountable in three years time as saying that I misled you.

CHAIR —I noted that you said in 2008 dollar terms, so I assume it was roughly current.

Dr Gumley —It is roughly current exchange rates.

Senator MARK BISHOP —I will just finish off this point. Mr Orme has considered the discrepancy between costings provided by the US procurement office and the GAO over there. He has considered the material and as part of his report he has made a set of recommendations to our government as to the way it should go forward?

Dr Gumley —I personally have not read his final report, because it was a report he was making to government, so I do not know precisely what is in it.

Senator MARK BISHOP —You are unable to confirm that this issue raised by the chair has been adequately addressed?

Dr Gumley —I know that Mr Orme questioned our project team on aspects of the GAO findings. I know they were questioned on it, but what Mr Orme has put in his report I do not know.

Senator MARK BISHOP —Thank you.

Mr ROBERT —We are second first-of-type but we are the fourth customer and you believe we will get the 70th aircraft—we will not hold you to that because you are not responsible for their schedule or workflow—in late 2013, early 2014. When does aircraft number one roll off? What date will the first customer get their aircraft?

Dr Gumley —AA-1 has been flying for about a year now.

Group Capt. Thornton —December.

Dr Gumley —It is eight months—the first aircraft has been flying for about eight months.

Group Capt. Thornton —It was the year before in December and the first model has flown about two months ago.

Mr ROBERT —Probably a better way of looking at it is: can you tell us when the 10th will be off? I am trying to work out what is the gap between the initial entry to service of an aircraft in a country’s air force and when we get our 70th.

Group Capt. Thornton —The US marines are the first service to declare operational capability and they are planning 2012 for IOC, and the USAF I believe is at 2013.

Mr ROBERT —Is it fair to say that there will be at least 18 months between the first customer receiving a substantial amount of aircraft for a combat capability and us receiving ours?

Dr Gumley —I can give some data that might be helpful. Assuming no customers defer and assuming no-one plays that race to the back of the queue and everything I talked about, there is planned to be nine aircraft in 2011; 13 in 2012; 28 in 2013, of which we might get four, but those four will probably be rolled out a little bit later; and in 2014 there are 68.

Mr ROBERT —Therefore there could be at least three years between the first combat capable aircraft flying in an air force, in this case the marines, and the Australian Air Force receiving its aircraft?

Dr Gumley —Those aircraft that I have just given you are the conventional take-off and landing, so in addition to that there is the STOVLs, which the US marines are getting, and that is how there is a discrepancy between the numbers for the conventional ones and the 70th aircraft off the production line. You have to add the two numbers together.

Mr ROBERT —With respect to managing risk, cognisant that some of the testing has lapsed, what is your view from a risk point of view that there may well be two or three years and 70 aircraft that go before ours has at least two or three years of flying and a potential for combat flying of the aircraft prior to getting ours? How does that mitigate the risk of a reduction in delivery?

Dr Gumley —You have picked it precisely. You have got two to three years of mitigation and so if the US slip a bit because of the T&E program, there is two to three years to catch up. In some ways it is analogous to the MRH helicopter that General Fraser talked about, that the Germans are running ahead of us and they have slipped a bit, but our program as a subsequent customer is okay.

Mr ROBERT —I do not have a lot of experience in aircraft design or how it rolls off manufacturing but, looking at other aircraft that the world operates and has built over that two to three year period, is it normal for aircraft designers to pick up issues that fold back into the design so that the 50th and the 60th and the 70th are better platformed with more bugs fixed than the first and the second?

Dr Gumley —Absolutely. There was a problem with the first aircraft, which has been flying for over a year now with one of its electrical actuators. That has caused a problem, and they have had to redesign the electrical actuator that goes in the aircraft.

Mr ROBERT —What degree is the risk the Commonwealth mitigated by us receiving the aircraft three years after the first batch go to the marines?

Dr Gumley —I talked earlier about the sweet spot of where you start acquiring aircraft and I think we are pretty close to it. The alternative is that you delay further and further. Of course the government has also confirmed the other major risk mitigator, which is purchasing the squadron’s Super Hornets, so in that whole decision about Super Hornets, which is the first part of the air combat review, and the government confirmed to go ahead with the Super Hornets is your master risk mitigator. Just supposing a disaster happened and something blew up in the aircraft and it was back to the drawing board with another two-year delay, Australia is getting a squadron of Super Hornets to cover a capability gap that does not exist now but could exist if something unexpected or disastrous happened with an alternative program.

Mr ROBERT —You may not be able to answer this. In your opinion are the Americans looking to deploy their initial aircraft into combat early?

Dr Gumley —I do not know. That is a capability question that I cannot answer. DMO is the acquiring organisation.

Mr ROBERT —The question I am going to is: by 2013 will an air force, most likely the Americans, have deployed the JSF into combat?

Dr Gumley —We do not know.

Group Capt. Thornton —Major General Davis is the PEO of the program and he stated at one of his meetings that he believed that by 2013 a JSF would have been in some combat operation.

CHAIR —When do we think that we will have a squadron operational, if we acquire them?

Dr Gumley —2015.

Group Capt. Thornton —2015 is when we are planning initial operational capability and that would be with the first squadron operational in Australia and then it will build up from there.

Dr Gumley —With every one of these advanced platforms it takes a number of years for the military to actually develop training, doctrine and practices. It is one thing having the physical airframe available at an airport, but then there is a lot of work to do to get it up to full operational capability. A good example there was the Collins submarine. The Collins submarine took three or four years for the crew to work up to full operational capability once the boats were working effectively. The Wedgetail aircraft is going to take a couple of years again to work up to full capability, and I would imagine any new airframe we introduce is in a similar situation. That, of course, is why we are keeping the classic Hornets going until towards the end of the decade, just to make sure there is a coverage.

CHAIR —You mentioned the JSF office is conducting a review of the GAO report. Who is doing that?

Dr Gumley —That is the JSF office in the US and not our people.

CHAIR —Yes, I understand that. Are they doing it themselves?

Dr Gumley —Yes.

CHAIR —I am just wondering about the prospect of the JSF office doing a review to see whether or not it is in fact making the mistakes the GAO says and coming up with the finding that says that they did make those mistakes and just forgot to tell you until the GAO reported it.

Dr Gumley —I will take that one on notice because I do not have that detail.

CHAIR —Just on that GAO report where it goes to the question of costs, the DOD reported that total acquisition cost estimates increased by more than $23 billion since their last report in March 2007. That is a $23 billion increase in the 12 months. They went on to say that it is a $55 billion increase since the program underwent a major restructure in 2004. That seems to be a fairly significant cost blow-out, $23 billion in one year.

Dr Gumley —Yes. I think a lot of that is based on extending the production line to longer years out. My understanding is the GAO report is based on out-turned dollars, in other words, inflation adjusted dollars, so as you start extending the program out you get more inflation coming into the total program.

CHAIR —This is not the GAO’s estimate—and I am referring to page 5 of their report. They state that DOD reported the total acquisition cost estimate increased by more than $23 billion since their last report in March 2007. If it is what you say, I suppose what they are saying is that they now anticipate a dramatic increase in inflation over the life of the project that they did not have before—or what a common reading of it would tell us is that there has been a cost blow-out?

Dr Gumley —We will get some information back to you on that.

CHAIR —But we do not know?

Dr Gumley —I am sure we do know in our program office. I do not personally know.

CHAIR —I could read a whole raft of other sections of this report but there are only one or two that I will trouble you with. Suffice to say, it is a worrying document. I should point out that I did in fact give advice to the CDF some weeks ago that I would be raising a number of issues associated with the GAO report, so I am a little surprised that we do not have some more direct answers about it. I quote from the report:

Midway through its planned 12-year development period, the JSF program is over cost and behind schedule. The program has spent two-thirds of its budgeted funding on the prime development contract, but estimates that only about one-half of the development work has been completed. The contractor has extended manufacturing schedules several times and test aircraft delivery dates have continually slipped. Repercussions from late release of engineering drawings to the manufacturing floor, design changes ... force inefficient production line workarounds.

Are we dealing with this? We have heard that we have a team of people over there. What are they doing in respect of these matters?

Dr Gumley —First of all, we do acknowledge there have been schedule slips. Where there is a difference between the program office and the GAO is in the extent of it. There is no doubt there have been schedule slips and people are trying to come to grips with the magnitude of them.

CHAIR —I will not go through some of these other things at this time. There is one other matter, though, that I would be interested in your comments on, and perhaps it is something that we need to also raise with the CDF and Chief of Air Force, and that is the alternative engine program for the JSF, which I understand is no longer the case. There was a competing engine supplier arrangement. The GAO makes comment about that and expresses concerns on the effect of doing away with that engine competition. Can you tell us anything about that?

Dr Gumley —For a number of years the project has said that the alternative engine program probably was not necessary and congress has reinserted it each year. There are conflicting arguments. One is that running two development programs, two development engines, means that you have got double the fixed cost and double the engineering cost. The alternative is that it provides competition in the marketplace for years to come and will keep both the engine manufacturers keen and competitively focused. So there are two rival views and that has been played out over the last few years. I can see merit in both arguments.

CHAIR —The Defence annual report refers to the acquisition of the Super Hornets and the JSF giving Australia a key edge in air combat capabilities. I am not trying to split hairs, but I just want to be clear about this. When we talk about a ‘key edge’ is that synonymous with air superiority? The committee has for some time expressed concerns about our capacity to maintain dominance in air superiority.

Dr Gumley —They are questions for Chief of Air Force. As I said, we are the acquiring organisation.

CHAIR —That is fine. There are no further matters on the JSF that anyone wants to raise? We are slowly but surely going through the list. Before we go on to the air warfare destroyer I would like to discuss the FFG. There are two upgrade programs on the FFG. In separate visits with Defence and briefings the committee was made aware of some concerns on the upgrade program for, if memory serves me correctly, the radar suite. Can we get some advice about what is happening at the moment with the FFG upgrades?

Cdre McKinnie —Admiral Robinson is overseas on duty. The FFG upgrade program is at a challenging stage where we are nearing the completion of a great deal of the development and production work but getting to the deliberate, difficult completion and sign-off phase. The project has had many delays, and that is well and truly on the public record. We are now closing the gap on the final systems, which are the key issues for Navy accepting them and taking initial operational release of the capability.

The lead ship, HMAS Sydney, was offered for initial operational release and last year Chief of Navy elected not to take initial operational release due to his requirement for the capability to be improved prior to delivery. The key issues there were with the electronic surveillance system, which is a very high-sensitivity electronic warfare system, a very sensitive receiver, and it is all about detecting the electromagnetic environments and providing early warning and cueing for the above-water warfare combat systems. There were additional issues that he was concerned about in terms of the maturity of the integrated logistics support package and some issues about safety case documentation—in other words, making sure that we were delivering a capability that was safe and fit for service.

We have been working with the prime contractor, ADI Ltd, now trading as Thales Australia, for some time and their subcontractor, Rafael, to work in a collaborative fashion to get the Rafael electronic surveillance system over the line. It is a C-Pearl ES system, electronic surveillance. We have had good progress and successes during this year on debugging the system, finding faults in software, finding faults in some of the inputs for that system, and we had a trials program in HMAS Darwin in May this year which has given us increased confidence that by about November this year we should be able to demonstrate a compliant system that meets the contracted requirements. It is on that basis that we wish to then reoffer that capability for Navy for consideration. It is important to the Chief of Navy in the context that this is a warning receiver and in his frame of reference it is a key issue in a decision to deploy the ship into combat operations. So we are on an ES system get-well activity to improve that capability.

There are other issues with the Link 11 tactical data link, which is also an important inter-operability and communications issue for deployment. That is being fast-tracked as best we can. We are working with the endgame in mind. We have a real determination to provide the best available capability to keep our Jacks and Jills at sea safe and to give the best delivery of that capability.

In the total capability requirement of this upgrade the real issue was major reliability programs and upgrade of the weapon systems, and many issues there have been well and truly demonstrated. We have major upgrades to the radar and sensor suites and they have been well and truly demonstrated. The anti-air warfare capability of the FFG is much improved with the installation of the Evolved Sea Sparrow Missiles and a Mark 41 vertical launching system in the forward part of the ship. That is a huge capability multiplier and we know that the ship is far superior in anti-air warfare terms to the pre-upgraded FFG. By the way, the Turkish Navy is seeking to leverage off our experience of that package involving the Sea Sparrow missile and vertical launching system, Mark 41, and they want to become a second customer of that development effort.

We have much of the ship capability demonstrated. We are on a get-well program to get over the line on the electronic warfare electronic surveillance systems and tactical datalinks and working with the contractors to deliver the best capability. The critical review point will be in November this year, which is a key contract milestone for delivery and acceptance of the lead ship, its combat systems and the supporting software.

Senator MARK BISHOP —All of your testing and trialling on the three or four problem areas have well and truly been carried out now. Are you assessing the data that is derived from the trials? Is that correct?

Cdre McKinnie —We are assessing data from program trials over several years. We have had to provide additional trial windows for demonstration and debugging of the electronic surveillance system. There was a major trials window in May. We have programmed further trials in August to again assess the adequacy of the new software fixes from Rafael that they have developed as a result of the May trials. We are taking every window of opportunity, be it alongside or at sea, to test and debug these systems and provide the best evidence not just to us as the organisation holding Thales and ADI to account but also to provide that evidence for Navy with the confidence they need to use the capability.

Senator MARK BISHOP —The reason I asked the question is because we had a discussion on this issue, about a month ago from memory, with Mr King who has taken overall responsibility for this project. My memory of his comments was that the trial had been done in May, that Navy and others were reviewing the data, that the reviews to that date indicated satisfaction with the trials and the data and there would be further work down the line, which you have confirmed. But I had gained the impression from Mr King—and I might be wrong in this—that the revision of the contract, the allocation of different and extra people by Thales and the heightened work programming in terms of the trialling and the data analysis had led Navy to a not final, but indicative, view that the ships would come online in terms of capability towards the end of this year. I am hearing you now not being quite as firm as Mr King. Are you saying 50c each way or has there been a change in position by Navy in that time?

Cdre McKinnie —No. I have a different style of description from Mr King. I was present at that same hearing. The issue is that we are DMO and my belief is that Mr King’s statement at that time was that DMO have a high level of confidence that we can be able to get an acceptable system, contractually compliant by November this year, which would be the basis for Navy to then say, yes, we can take initial operational release and deploy that capability. There are two sets of transactions. One is for us to take contractual acceptance and the second is Navy signing off with initial operational lease and deployment.

Senator MARK BISHOP —Who is the negotiating party—DMO or Navy?

Cdre McKinnie —DMO.

Senator MARK BISHOP —Does DMO do the contract?

Cdre McKinnie —Yes.

Senator MARK BISHOP —And if you are satisfied in November of this year that there has been delivery of all contract terms, you sign off and authorise payment. Does Navy then have right of rejection of the ships that DMO, the contracting party, has signed off on?

Cdre McKinnie —I believe it is, yes. Navy makes its own initial operational release decisions based on advice from DMO and other authorities. They have an RAN Test Evaluation and Acceptance Authority, RANTEAA. They conduct independent assessments and operational evaluations.

Senator MARK BISHOP —I knew that was the case—that is why I asked. So DMO, as the contracting party, can contract to buy initially six—later four—ships; have extensive contract review; the prime and its subcontractors can comply with all terms of the reviewed contract and DMO can then say that the contract has been 100 per cent complied with and recommend acceptance; but Navy—the user—according to you, has an absolute right of refusal to accept the ship or ships for a range of reasons you just outlined. How then, in terms of the discussion we have been having for the last two hours regarding all those matters, do we have a workable commercial procurement industry?

Mr Gillis —There is also a different player in the capability development group led by Admiral Tripovich. They are effectively the broker between us and the services. They are the capability definers, managers et cetera. The other part of it is that in the FFG program Navy works very closely with us in the program management stakeholder groups. So this is part of the discussion where I know Mr King has been working very closely with the previous Chief of Navy and with the current Chief of Navy to ensure that there is no confusion when we actually get to this delivery stage. Historically, a number of vessels have taken many years to be formally accepted by the Navy. We are advocating a significant improvement in that process and working more closely with Navy to ensure that there is not that gap between their expectations and what we actually deliver against the contract.

Senator MARK BISHOP —We know that there has been contract scope change in a whole range of projects over the last 15 years and that the agency—Army, Air Force, Navy or whatever it is—that is going to use the equipment in due course has a whole range of expectations. But if the contract has been complied with, the product has been delivered and the negotiating party, DMO, certifies to that extent, how does Navy with whatever expectations they may have get the right to refuse delivery of the product when the negotiating agent, DMO, certifies that the contract has been complied with?

Mr Gillis —That is a very complex question.

Senator MARK BISHOP —It is a simple question.

Mr Gillis —It is very complex in that there is not a simple answer to this, because you will get over a period—for example, the FFG program which has lasted some nine or 10 years—what they call ‘contemporary requirements’. They have different operational scenarios and different operational requirements which are genuine things that the Chief of Navy might request of us. What we have got to do is delineate those requirements from our contractual position with Thales. We have got to complete the contractual obligation with Thales. If in fact Navy does have additional requirements—genuine operational requirements—they would then go to capability development through Admiral Tripovich. Admiral Tripovich would then consult with government about whether funding and schedule were applicable and then they would come to us and say that they needed additional capability or additional requirements until that vessel is operational.

Senator MARK BISHOP —With due respect, that is a different issue. If the contract as reviewed, drafted and agreed has been complied with and the negotiating party so certifies and delivers the product to the agency, Navy or Air Force may well have a whole range of expectations and different operational requirements post-November 2008. I accept that. But that has nothing to do with the reviewed contract as signed and delivered in February 2006 or 2007. I want to know how we can have industry certainty when Navy can say post-November 2008 that its then operational demands are not satisfied by a ship that its negotiating agent signed off on whenever we did the upgrade review. That just strikes me as virtually commercially improper.

Mr Gillis —I agree with you. Having come from a shipbuilding background myself and having delivered ships to a number of navies around the world, the position that delivering what you have contracted to deliver should be accepted, and should be accepted by the organisation, is a principle that I hold to and I know that the DMO also holds to. There are difficulties in that acceptance process. I think that is one of the things that David Mortimer is actually looking at in his review of the acquisition process at the moment.

Senator MARK BISHOP —Does this then come down to a dispute between the principal negotiating arm, DMO, and the agency to which you deliver the respective service? Does that have to be resolved between yourselves as a protocol? What I am hearing you say is that there is this grey area of dispute post November this year, which may or may not be a problem, but if it is a problem obviously industry is going to bear a large whack of the cost.

Dr Gumley —No, industry is only required to deliver what is in the contract. It would be unconscionable of us to ask industry to do more than that. As far as we are concerned, Thales has to produce what is in the contract.

Senator MARK BISHOP —And when they do?

Dr Gumley —And, when they do, then we have to have the debate with Navy about acceptance into service.

Senator MARK BISHOP —What happens if Navy just play hard-ball for whatever reason? What if they say, ‘We don’t want the ship, Dr Gumley,’ and they eyeball you to that effect?

Dr Gumley —I have got nowhere to go, have I? The money for the project has been spent. If they do not want the ship, they do not want the ship.

Senator MARK BISHOP —Can you anticipate that happening?

Dr Gumley —I would not like to speculate.

Senator MARK BISHOP —Okay. We will revisit this in due course.

CHAIR —I understand from earlier briefings we had with you some weeks ago about arrangements for the DMO to have negotiated up front a clear arrangement with the respective service, that that part of the process has improved, but it might be useful for the transcript if you want to say something about that.

Mr Gillis —Having just recently worked as the program manager for the LHD program, we had two years of consultation with Navy, Army and Air Force to ensure that the certification baseline for those ships was absolutely documented down to the condition of the PA speaker in the second level being assessed at a particular standard by a particular person for the first vessel, not the second, and that would be acceptable, and that was signed off by 11 signatories within the services.

The difficulty we have with a legacy program like FFG was that the documentation of the acceptance process and all that sort of thing was not as clear as it should have been. One of the things that we have increased and we have improved significantly is to ensure that the documentation about what we as an organisation, DMO, actually have to deliver through capability development to the services is documented as best that we can at the time prior to contract, which is a part of the Kinnaird two-pass process. We actually have documented tender quality pricing with detailed processes in respect of acceptance because that is what industry wants. Industry wants clarity of exactly what they have to deliver to us. So there was a three-way process between industry, DMO and the organisation. But also with capability development there is the broker to ensure that everybody was clear about the requirements.

Senator MARK BISHOP —Coming to November 2008, the trials are done, the data is analysed, Dr Gumley is prepared to certify that the contract has been fully complied with and he wants to hand the ship over to Navy: who makes the call as to whether Navy accepts? Is that a decision for Chief of Navy? Is it a decision for the CDG? Is it a decision for the minister or his nominee, or who makes this call?

Dr Gumley —The Chief of Navy has the right to accept a ship into service.

Senator MARK BISHOP —Is that by practice or by statutory fiat?

Cdre McKinnie —I believe it is by practice. Over many years we have had a good process that has run for ship acceptance and delivery. It has been improved with the Kinnaird windows and with more rigour in defining initial operational release and operational release. Those processes are evolving. In the Navy world we have a ship acceptance certificate, TI338. In the Anzac ship program it has worked really well. When the contractor believes that he is able to offer a contractually compliant product there is a formal offer. There is a disclosure of everything we know about the state of the ship and its systems, trial cards, problems and bugs. There is never, ever, 100 per cent full compliance of every requirement and contractual issue. We then go into the ‘so what’ analysis about the significance of those issues and we make resolutions as to what issues have to be resolved by the contractor at their expense post delivery, what needs to be resolved by DMO and what other issues need to be resolved by Navy. They are in various categories which are risk based and a number of them are focused in the safety regime. It is all about assessing that fitness for service. That TI338 is then  the basis for us saying to Navy: ‘We want you to consider this for operational release or initial operational release.’

That TI338 set of certificates is supplemented by a bunch of other assessments made by Navy and specifically by the RAN Test Evaluation and Acceptance Authority. Recommendations are taken by Director-General, Navy Certification Safety and Acceptance, a role I used to have. We go to CN and present a case. We say, ‘This is what you have got, Sir; these are the risks, these are the transitional measures proposed by contractor, DMO and Navy,’ and away we go.

Senator MARK BISHOP —The reason I pursued that issue this morning is that for many years now Dr Gumley and Mr Gillis have been telling us about the significant improvements that have been needed and that they have set about implementing within the DMO as to a whole range of issues. Over time, we and other committees have seen the improvement before our very eyes. That is credit to everyone. I was just a bit surprised when I have been approached by a range of industry participants in the last two or three months who have advised me of this position that key armed forces have the absolute right to refuse delivery of a platform or a product notwithstanding the fact that the agency that has negotiated on their behalf, the DMO, either has signed off or substantially signed off on contract compliance.

Dr Gumley —The way to get it right is to make sure that the original specification is correct, because then there will not be a dispute at the back end.

Senator MARK BISHOP —Yes.

Mr Gillis —And there is a distinction between those issues that are safety related—and it is absolutely critical for us to ensure when we deliver a ship that it does meet all the current and contemporary safety requirements—as opposed to some things which may be a capability enhancement. They are the things we have to say no to unless we have a process in front of us where capability development, government and the services have agreed to the funding and to the schedule to actually deliver those particular aspects.

Dr Gumley —And with a 10-year program it is possible that the bad guys have done something different with military technology and you need to do something to upgrade your platform pretty much as you are bringing it into service. That can happen. The correct way of doing it is probably a new project fully open and visible to everybody, fully costed, and you work on it then. Of course, we did that with the Collins submarine. The contract went for many, many years and then there was a subsequent project, C1439, which was to bring it up to the next level of capability. At least that was open and visible to everybody.

Mr Gillis —An example of the improvements is that we were able to recently deliver a replacement to HMAS Westralia actually ahead of schedule and under budget and Navy accepted. We did go through a TI338 program where we actually had a number of deficiencies in respect of the ILS et cetera. Tenix, who delivered the vessel, was paid a bonus for delivering ahead of schedule and actually meeting all their criteria, but there were a number of items that we had to improve and work with Navy on. Navy accepted the ship and the ship is in operation. There are still some things that were outstanding that we are resolving even today.

Mr ROBERT —When the Chief of Navy met with the committee 10 weeks ago he expressed that his single biggest concern was the Rafael C-Pearl electronic surveillance system. My understanding is that the tests earlier this year failed to meet all the requirements of Navy and that you are moving forward to October-November. If the Rafael C-Pearl does not pass, what is the plan?

Cdre McKinnie —We are focused on satisfying the contract requirements and the requirements of Navy right now. Our energies are very much focused on getting C-Pearl over the line. I have been given advice by General Manager Programs, Warren King, that we are not in a world where we can resort to looking at alternative systems in the current funding environment, and I think that is a valid incentive to all of us to perform. Our friends in contracts are very aware of what is at stake; we have to get C-Pearl over the line. I am aware of the opinions that were presented by RAN to Chief of Navy and some of the issues that were raised by Chief of Navy. It comes down to the level of confidence in the tests that were done. It comes down to the interpretation and analysis of the test results and Rafael is playing a strong line saying we believe that the requirements have been substantially met and we are closer to compliance. DMO is working to get them there. We know we have further remedials and improvements to do to address the operational concerns that were observed by the Navy operational community in those May trials: angle of arrival detection errors and what is called emitter-splitting are phenomena that we are investigating and providing system fixes for now. We are focused on getting the C-Pearl system to the highest level of capability possible and offering that to Navy. I have to add here that the requirements baseline against which the C-Pearl is being offered evolved after the original contract was signed. The FFG contract was signed against a certain system of specification and the detailed operational requirements and operational concept documentation for FFG upgrade evolved after that contract signature. This is a pre-Kinnaird project. It is imperfect. Some of the reason why we are having pain and difficulties in demonstrating the required capability is precisely because of the immaturity of requirements that were originally put in place.

Mr ROBERT —Whilst I understand all of that, you are still the acquisition organisation which means you actually need to have a risk-mitigation strategy and a plan for when things do not go right. So the question remains: if the tests in October-November do not meet requirements, what is the plan?

Dr Gumley —It will go back to the defence investment committee and it will have to go through the government processes again because there will be no money; therefore, anything that is alternative will have to be funded from somewhere, which means we are into an entirely new acquisition process.

Mr ROBERT —Are you implying that the October-November trials are indeed a drop-dead trial? If it does not pass then we are back into a new funding process?

Cdre McKinnie —The FFG upgrade prime contract has absolute requirements on the prime, ADI, trading as Thales, to provide delivery and acceptance of lead ship in its systems in November this year. Final acceptance of the total program is in November 2009. The obligation is on them to demonstrate a compliant system and, yes, that is a very pointed position of review where, as you say, no-go decisions could be made.

Dr Gumley —If the contract has been met and the system is still not suitable to Navy, we are then in the position of saying, ‘What do you do next?’

Mr ROBERT —That is correct, which is where the senator took us before.

Dr Gumley —If they have not met the contract then it is the contractor’s obligation to remedy until they do meet the contract. There are two issues: one is if they do not meet the contract, that leads you down one path, and the other is that they meet the contract but it is still not acceptable to Navy and that leads you down another path.

Mr ROBERT —On that line, putting aside Navy for a second, if come October-November they do not meet the contract, is DMO intent on actually giving them more time to meet the contract?

Cdre McKinnie —We have also been looking at what would happen if C-Pearl were never going to get over the line. In a systems engineering and what-if way forward, we have made investigations about the suitability of alternative systems. There has been engineering scoping work. There have been RF surveys and a level of expenditure on checking an alternative system that we believe could meet Navy’s requirements. In fact, it was the lead competing system that was being considered at the time the C-Pearl decision was made. We have evaluated that system in the Joint EW Support Unit in South Australia.

Mr Gillis —One of the things we have to do is ensure that we do have a contractual obligation through Thales to Rafael to give Rafael every opportunity to actually deliver against their contract. And that is what we are doing. We are focusing on that. We have risk mitigation strategies but we are not putting our resources towards that. Our resources are being put towards actually getting the Rafael system to work.

Mr ROBERT —Is it fair to say that Rafael understand the seriousness and the absolute need to make their system work come October-November?

Mr Gillis —Absolutely. It is one of the reasons why we have our senior program manager actually directly involved with the service chief to ensure that he is actively involved in ensuring that Rafael and Thales understands and that everybody understands the critical nature of getting the right decision.

Mr ROBERT —The spectre of the Seasprite is haunting us all. I would suggest the committee will take a degree of interest in the October-November trials.

Mr Gillis —As will we all.

Dr Gumley —You asked earlier—and I invite your comment as to whether you want to take it on—which are the top 30 projects and so on.

CHAIR —Yes.

Dr Gumley —Would it be convenient if I referred the committee to page 21? This might be the easier way of doing this. I will just read through the projects and put them into three categories.

CHAIR —Yes.

Dr Gumley —The Globemaster C17 is off the shelf. The F18 Hornet upgrade is an integration project where you get the kit from overseas but clearly you have to get the wiring and do everything yourself locally, so I put that into integration. The next F18 Hornet project is also integration, as is the third one—the structural refurbishment. I should point out that all of the F18 Hornet projects are going well. I have no concerns with them. For the ADF air refuelling capability we are a lead customer. At the moment we are suffering about a five-month delay on that project. It is not as bad as many of the other lead projects but there is about a five-month delay. The MRH is off the shelf. We have already debated that. If there are delays in other countries I guess we are getting close to a lead, but it is off the shelf. We have pretty much found ourselves as the lead customer with regard to the Tiger, although we did not start as the lead customer. We are the lead and only customer with regard to the Seasprite. We are the lead customer with regard to Wedgetail. AWD is an off the shelf design, but it is an integration project, so we have lowered the risk. We have discussed that. Eagis combat system is off the shelf.

CHAIR —How many American ships have got Aegis?

Cdre McKinnie —Plenty.

Dr Gumley —It is 82 or some number like that so we are well down the line there. We talked about Armidale class; we are the lead customer there but it is more of a commercial design. That project has entered service and is doing a good job. FFG is somewhere between an integration project and a lead customer. We have just debated that. The SM1 missile replacement is off the shelf. For a long time now we have been the lead customer for the Anzac ship project. Anti-ship missile defence is lead and technological high-risk—the ASMD projects. I might be able to discuss that with the committee at some other time. The replacement integrated torpedo system is off the shelf using an American torpedo. The Collins class reliability is lead customer. We are, in fact, the only customer because we have got a unique design. The replacement combat system is off the shelf. It is the American combat system that we have to integrate into the submarine. In land division, the tank is off the shelf and on time and on budget. It is purchased FMS. It is low risk and is going well. It is being used. We are a lead customer on the M113 armoured vehicles and you saw from the amount of money delayed between there and there that we dropped about $100 million of spend that year because the brakes did not work and it took a year for the technological issues around the braking system to be proved. That project is back on track again now but it did go through the lead customer process.

We are lead customer on Project Bushranger. Integration is the Echidna project. The lightweight torpedo is an integration project. We have got some difficulties on that. That is where the issues are—in the integration. We are off the shelf for the actual torpedo itself. Explosive ordnance reserve stock is off the shelf. Jindalee was lead customer. Vigil Air was lead customer and only customer. Amphibious maritime support is a combination of off the shelf and integration in the joint strike fighter by the time we get the 70th aircraft. It is a development project now but it will be off the shelf by the time we get around to taking aircraft.

Mr ROBERT —That is about half; about 14 out of 30?

Dr Gumley —Yes.

Major Gen. Fraser —The number of aircraft accepted by Germany is eight at this point in time. That is eight NH90. Plus there are a number of other nations that have accepted aircraft.

Mr ROBERT —Can I take from that that if push came to shove on indigenous training that there is an opportunity for us to train on those eight?

Major Gen. Fraser —There is a means to gain training through the company, that is correct, whether it is with them or with other nations.

CHAIR —I want to thank you all for your presentations. We are clearly behind time. I am proposing to keep with the schedule so that we do not dislocate the timing of others who have arranged to come here at predetermined times and will reconvene at some future time to go through a range of other matters. But I do appreciate the evidence that has been given. As has already been mentioned by Senator Bishop, those of us who have been around this debate for some time appreciate the improvements that we have witnessed in the way that acquisitions occur. Billions of dollars of taxpayers’ money is spent each year on Defence acquisitions. It is never going to be an easy thing because of both the volume and the nature of what you are acquiring. You will always, I suppose, get the rougher end of the pineapple here than might be the case elsewhere, but it is also appropriate for us to acknowledge that there really have been improvements. I recall spending about a year doing a report on government purchasing about 15 years ago and the changes that have occurred from then until now are dramatic and positive. Thank you for that, and I look forward to seeing you at a future hearing.

[11.34 am]