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Foreign Affairs, Defence and Trade Legislation Committee
Defence Materiel Organisation

Defence Materiel Organisation


CHAIR: I welcome Mr King from the DMO.

Senator CONROY: Land 400 is one of Defence's most ambitious capability projects. Together with the JSF and the Future Submarine it is one of the big three—a $10-plus billion purchase of armoured land combat vehicles for Army. Please advise the committee whether Land 400 is still expected to result in around 1,100 new vehicles to replace the existing M113 Armoured Personnel Carrier and the Australian Light Armoured Vehicle.

Mr King : I think it would be appropriate for Admiral Jones, who is head of the Capability Development Group, to respond to that question.

Vice Adm. Jones : LAND 400 at the moment is leading towards first pass to government. We are preparing the first submission, including the basis of provisioning but also looking to be able to describe the full range of Land 400, both in terms of the ASLAV replacement component and the APC, as well as specialist vehicles and other training and simulation elements of the project.

Senator CONROY: I was asking whether you expected it to result in around 1,100 new vehicles.

Vice Adm. Jones : It is more likely to be around 700 vehicles.

Senator CONROY: That is a lot less than 1,100.

Vice Adm. Jones : The issues that influence provisioning will be the amount of protection for each vehicle as well as the size and so on. The Chief of Army's requirement is for a minimum of about 700.

Senator CONROY: Can you give me a breakdown of the 700—as compared to the original 1,100?

Vice Adm. Jones : It would probably be best if we took that on notice because there are a range of specialist vehicles as well in that breakdown.

Senator CONROY: When was the decision to reduce it from 1,100 to 700 made?

Vice Adm. Jones : I will ask the Chief of Army to talk about the numbers because part of this relates to the Plan Beersheba vision as well.

Lt Gen. Morrison : There are, essentially, three broad vehicle types being looked at under the large project Land 400. One is to replace the armoured reconnaissance vehicles we currently use, which are known as ASLAVs. There are currently just 250 of those vehicles in the Army inventory. There is a second vehicle, the infantry fighting vehicle, also known at the moment as the armoured personnel carrier. We have in excess of 700 of those vehicles, but some of those are now, with the changes we are making in the Army, likely to become surplus to requirements over time. We will draw down the number that we need.

And then there is a third type of vehicle called a mobility vehicle, a vehicle that supports other armoured vehicles to traverse difficult terrain. They will be entered into service and replace a capability because we do not have that one at the moment.

Senator CONROY: Okay.

Lt Gen. Morrison : That has allowed Army, in partnership with the Capability Development Group and the DMO, to come up with a broad number of vehicles that we would like to see in the future LAND 400 enabled army. That figure—you have identified a number; Admiral Jones has given you something a little bit below that—is all going to be dependent, really, on the cost per unit, industry's ability to provide it, where it will be manufactured and how, and the level of protection we deem as a minimum. We are talking about vehicles now, of course, that will be operating beyond 2030.

Government will consider at first pass LAND 400 this year. That will set the parameters within which the DMO, CCDG and the capability manager responsible for this, the Chief of Army, will then conduct detailed and ongoing discussions with industry to decide what the cost of these likely vehicles will be and therefore how many we can afford and what numbers will be accommodated.

Senator CONROY: So are we now working to an existing budget and saying we can have as many as you think, depending on their cost, which you are estimating is roughly, for total vehicles, around 700? Or are we ordering 700?

Lt Gen. Morrison : We are not ordering anything at the moment.

Senator CONROY: To go to a first pass, you have to put a nominal dollar figure or vehicle number figure, I am assuming.

Lt Gen. Morrison : That is correct, and that will be considered by government when it is taken to first pass.

Senator CONROY: That is a substantial reduction from the 1,100. Where did the 1,100 number come from?

Lt Gen. Morrison : I am wondering myself.

Senator CONROY: So it is 700, give or take, depending on the actual cost per unit?

Lt Gen. Morrison : Correct—and indeed what capabilities the government decides will be intrinsic to the vehicles that we eventually procure.

Vice Adm. Jones : I guess the other aspect, too, is that there will be a number of projects which will go forward for government consideration this year, but also there is the white paper that is going to be formulated, so some of these, particularly these big projects, will have to be borne in that context.

Senator CONROY: Sure. It is just that I was confused because I mentioned 1,100 and Vice Admiral Jones indicated that he thought it was going to be around 1,100, so he seemed to have heard of the 1,100 number, so I assumed it was fairly common.

Vice Adm. Jones : This project has a long antecedence. It goes back to about 2006, and there has been a fair amount of maturing over that time.

Senator CONROY: I appreciate that, but it was 1,100 up until some point in time and now it is 700.

Lt Gen. Morrison : I think it is best not to think of it in terms of a definite number at this stage. There are variables that will have to be considered not just at first pass but as we interact with industry between first pass and second pass. I believe that I am due to brief you on a couple of Army matters next week, and LAND 400 is one of them. I will bring with me to that the types of vehicles that I have just spoken about, the indicative force structure of a future Army, and then take you through the first and second pass process.

Senator CONROY: Thank you for that. This question is probably more for the minister. Is the government still intending to give in-principle first pass in April this year and release preliminary tender guidelines to industry by 2015? Sorry, Minister.

Senator Johnston: First pass for what?

Senator CONROY: On this project.

Senator Johnston: Oh, LAND 400.

Senator CONROY: Is the government still going to give in-principle first pass in April and release preliminary tender guidelines to industry by 2015?

Senator Johnston: I am not in a position to say yes or no to that because the brief has not come forward to me yet. There are a whole lot of variables that impact on the timing of that, but there will be announcements once first pass is done. You will see and hear what is involved in first pass next week. It is not something that, three months out, we can nail down at this stage, but we have said: this year there will be first pass for LAND 400. That is assuming that it gets through first pass. So bear with us on this. It is a seriously complicated, complex, expensive program, and of course the securing of safety and life preservation in armoured vehicles is a really serious, front-of-mind issue for government and for, of course, Defence.

Senator CONROY: You have probably been about as precise as you can be on the time line for it, so I will follow up at the next estimates. When does Army believe the existing fleet will be obsolete?

Lt Gen. Morrison : The armoured personnel carriers have utility well into the next decade. They were the subject of a major upgrade. That has only been completed within the last few years. The M113AS4s, as they are known, will see service in the Australian Army until around 2025. The ASLAVs are the reconnaissance vehicles which you may have seen in film footage from Iraq and Afghanistan and, indeed, East Timor. They have a life-of-type much closer to the present time. At this stage, the advice that Army has received through scientific testing with the DSTO—and that advice has been provided to government—is that we will need to look at replacing those vehicles in the early years of the next decade.

Senator CONROY: Notwithstanding that—and appreciating the minister making the point that it is complex and they are still working through the briefs—is there any risk of a capability gap with either of those vehicles? Certainly not, from the sound of the first—

Lt Gen. Morrison : It is very easy for a general to give the answer I am about to give because, of course, if government decides, and resources are made available, there are off-the-shelf replacements for ASLAVs that would have great utility for the Army well into the 2030s that are available, but of course government has to make judgements based on balancing a number of other pressures, and it is not my call to make that decision. Nonetheless, I am confident that, on the time line that has been set for LAND 400 now, there will be, subject of course to government approval, no capability gap.

Senator CONROY: Can you assure the committee that DMO will ensure the vehicles acquired as a result of LAND 400 will be interoperable with existing ADF capabilities such as our LHDs, our sea-lift ships, our airlift aircraft, our battle management system and any other relevant systems?

Mr King : Yes.

Senator CONROY: Is LAND 400 still assessed as being a $10 billion project?

Mr King : It is in excess of that. But I will just make this point: that is an out-turn budget and the program is probably 18 years. One of the weird things we do for budgeting is talk in 'out-turned'—which is great for budgeting, but, in trying to have a handle on what that means in terms of today's dollars, it is deceptive because you are talking about dollars that are going to exist in 15 years from now. And what that tends to do, by the way, is: if you make even small changes to capabilities of stuff, you see large swings in the apparent value of the projects. So, in out-turn dollars, it is in excess of $10 billion at the moment.

Senator CONROY: I have seen reports recently that Geelong is campaigning to have LAND 400 located in that city. Given the collapse of the automotive industry in Geelong in recent months, and the presence there of skilled labour and car plants, is Geelong being assessed as a suitable option for LAND 400?

Mr Richardson : We have not yet got to first pass. There are obviously a variety of possibilities.

Senator CONROY: Minister, is Geelong a possibility?

Senator Johnston: I did receive a delegation from Geelong, who were—

Senator CONROY: You were not alone, I assure you.

Senator Johnston: doing their very best to promote Geelong as a viable place to carry out work for LAND 400. It took me some time to explain to them that that is not the way the system works; we do not decide things from the perspective of where we are going to do them first. Once I had explained to them the first and second pass Kinnaird structure for acquisition, I think they understood that they had possibly jumped the gun a bit.

Senator CONROY: What are the opportunities for Australian industry to participate in LAND 400?

Mr King : If I could just get this in context: this is still being formulated inside the department as a whole, and we have not gone back to government yet with the department's proposals for first pass. But, in the broad, we consider three elements of in-country work: assembled in Australia; manufactured in Australia; and, at the extreme, designed and manufactured in Australia. What we have done in order to inform government is to put quite well-thought-through definitions of what those mean in terms of Australian content, and we will formulate all of those matters into a package that we will put through to government as part of first pass consideration.

Senator CONROY: It has been put to me that, under the existing guidelines, Australian business will not have an opportunity to compete for work in LAND 400. I appreciate that you are not at a stage where you have finalised your current proposal, but is that a fair characterisation?

Mr King : No; it is just completely wrong. We have been quite conscious that this is a big program; we have been quite conscious that there are opportunities where Australian industry could participate, and at this point the purpose of making these definitions is in order to provide government with the range of options that might exist, and then, depending on government approvals, go to the market to seek solutions. So it is just quite wrong.

Senator CONROY: Thank you for clearing that one up. Will LAND 400 comprise a single multipurpose vehicle filling both cavalry and combat roles?

Vice Adm. Jones : No.

Senator CONROY: LAND 400 is scheduled for IOC in around 2025; is it not the case that an MOTS solution selected even in the next 12 months would be based on technology that is at least 10 years old and will be obsolete by the time IOC is achieved?

Major Gen. McLachlan : That is certainly not our understanding. A MOTS vehicle simply reduces the amount of risk it would take to develop a vehicle of that type ourselves. With the acquisition of a MOTS vehicle we would be very careful to ensure that the through-life support options allow us to do continual technical refresh and also scheduled block upgrades so that we are maintaining a cutting-edge capability throughout the life of type of that particular type of vehicle.

Senator CONROY: I want to move on to SEA 4000 AWD. The re-baselining of the AWD schedule by the previous government had the effect of extending the AWD program and avoiding a decline in naval shipbuilding skills ahead of the commencement of the future submarine program. Can you confirm the revised schedule reduced program risk?

Mr King : I am sorry, what was the question?

Senator CONROY: I am sorry; I will speak more clearly into the microphone. The re-baselining of the AWD schedule by the previous government had the effect of extending the AWD program and avoiding a decline in naval shipbuilding skills ahead of the commencement of the future submarine program. Can you confirm the revised schedule reduced program risk?

Mr King : It did reduce program risk; that is correct.

Senator CONROY: Can you confirm the revised schedule did not increase the cost of the project or cost any jobs?

Mr King : No, it did not increase the cost of the project and it did not cost any jobs.

Senator CONROY: It has been reported that the AWD acquisition is now confronting new and unforeseen cost blow-outs. Could you please advise the committee on the truth of these reports.

Mr King : Yes, I can speak generally to that. As you would be aware, the Minister for Defence and the Minister for Finance announced that there would be an independent review of the air warfare destroyer.

Senator CONROY: But what changed?

Mr King : Incrementally the program has, since its second pass, run into challenges, which you would expect. These projects come with a number of problems. The first is that when we started this program there had not been an active shipbuilding program for a number of years. Secondly, we were building the most complex ship that has ever been built in Australia. I think the third one is that we are only building three ships, and you obviously do not get economies of scale out of three ships.

There is no single point of problem in my view, but of course I do not want to get ahead of the expert team that has been assembled to look at the project. Effectively the decision to shift the schedule of delivery, which delayed the delivery of the first ship and put a bigger period between the subsequent ships, de-risked elements of it, but there are quite clear cost pressures coming on the ship construction part of the program. These arise for a number of reasons, and I think the expert team will get to the heart of that. We are anticipating that their report will be available for government midyear. I do not want to get ahead of that, but there is no doubt in my mind that there are problems here that need to be looked at and solutions identified to continue with the program.

Senator CONROY: I am a little confused. You did confirm that the revised schedule reduced program risk?

Mr King : That is right.

Senator CONROY: You did confirm the revised schedule did not increase the cost of the project or cost the jobs?

Mr King : Yes.

Senator CONROY: So what has changed since September 2013 when this program was reported as being on time and on budget, and suddenly after September 2013 there are reports of cost blow-outs?

Mr King : I am not sure about 'on time and on budget.' The first part of what I confirmed is correct—those changes did not do any of the things you have suggested. However, there are underpinning matters of complexity about the program that exist irrespective of those decisions, and those complexities continue to accrue. There are two elements to the program. There is the total program that was approved at second pass, which is the whole program to deliver these ships' capabilities. In that program there is not just the acquisition of the ships—there is the integration of the combat system, there is the acquisition of the Aegis system from the US, there is the development of the support systems, there is the development of the facilities and all of that. And in that is a contingency.

So, the program is still within budget. An element of that is the ship building program, and that ship building program has seen incrementally emerging cost pressures over time. They do not just suddenly appear because one thing goes wrong—they could, but that is not what is happening. It is incremental pressure growth. That budget pressure comes about in two parts. It comes about because of the cost of the work that companies are performing, and it starts to show that the actual cost of the work performed is greater than the budgeted cost of the work performed. That grows incrementally in different areas, in addition to which there are risk matters which industry has not confronted yet for which you make an allowance. When we add up the budgeted costs of work at the moment against the actual costs and put an allowance in for risks that might materialise then there is pressure on the ship building element of the budget.

Senator CONROY: I am trying to unpack your answer there. You said in terms of cost plus contingency it was inside budget.

Mr King : That is the whole approved program from the original second pass.

Senator CONROY: I got the sense that in the construction forecast as construction outcomes so far were on budget. Please correct me if I got that wrong but I thought you said 'actuals against forecast was okay'. Have you now looked at a new risk allowance and added a risk allowance? Can I clarify that? If you can help me understand, these new risk allowances are on top of the existing contingency?

Mr King : No.

Senator CONROY: Are they an expansion of the existing contingency? Please help me out.

Mr King : It would probably be better if I start that bit again. At my level or at my project's level, there is a whole range of costs including the construction of the ships plus other things such as the acquisition of the Aegis Combat System, the acquisition of missiles, the acquisition of facilities and a contingency. At that level, the project is operating within its approved budget. A very significant element of that is the construction of the ships.

The construction of the ships is being implemented under a contract which is called an alliance based targeted incentive agreement. That means is our two partners—that is, the shipbuilder and the combat system integrated—made an offer to us, which we accepted, to build those ships to the right performance level for what is called a target cost estimate. Within that target cost estimate for industry to manage is a management reserve, so you add up all the costs you anticipate and you add some things for what you do not know and that becomes a targeted—

Senator CONROY: Is that 10 per cent, 20 per cent or 30 per cent in these cases?

Mr King : The original amount, off the top of my head, was about $280 million so about five or six per cent I think. I happened to be a part of the project team at that point. We also then established a second-level management reserve because it is just good budget practice. The total amount of management reserve that was established at the start of the program within the TC—so this is not government contingency—was about $500 million.

Senator CONROY: So that is about 10 or 12 per cent?

Mr King : Yes, and that was thought to be a reasonable amount in the circumstances.

Senator CONROY: Again, so I am not confused, that is not the contingency?

Mr King : No.

Senator CONROY: So the government has a contingency on top of that?

Mr King : That is correct. What had happened in other major projects such as the Collins project, which was fixed price, was that it was proposed by many in lessons learned that taking on major developmental high-technology construction projects under a fixed price contract was unreasonable for industry and resulted in a position potentially at some point down the path where industry was unable to complete the project in the allocated budget and you would get a breakdown between government and industry in delivering the project. So from that lesson learned and from other studies done at the time starting with the air warfare destroyer project—

Senator CONROY: I could give you a few personal examples too from my old portfolio.

Mr King : It was considered a reasonable risk-sharing proposal that we should execute the project under this alliance based target and incentive agreement or under an alliance. I got involved at about that time and I was a little more hard-nosed because alliances were a bit soft for me. We put in 18 key principles, but one of those key principles was that the industry participants, who we had join us all the way between first and second pass, at our cost, would offer to deliver the goods and services—ships—for a price. There was no question, for example, that this was just a vague notion; industry would deliver those ships for that price. The price that was set is the target cost estimate and, as I said, that target cost estimate included a management reserve that industry and DMO as a partner use as appropriate. But it is not contingency. The risk that accrues to the Commonwealth in that arrangement is that, under the target cost estimate, there is a 50-50 share line. So, for every dollar we could deliver the ships under the target cost estimate, industry would get 50c extra profit. Every dollar over the target cost estimate, industry would lose 50c of their profit and DMO would have to put in 50c extra.

In a normal fixed price contract, I can go to the government and recommend that I agree with the cost of the project. The cost of the project is, say, $1 billion, it is fixed price and then I add a certain percentage for perceived risks, and then that becomes the project. The difficulty with the target cost estimate that I had to do at the time was to estimate the likelihood of risk that industry would not be able to deliver the project at the target cost estimate, so I had to build in a contingency at the project level.

Senator CONROY: Sorry to interrupt. I am just conscious that Senator Whish-Wilson has a couple of very quick questions and has to leave shortly. Perhaps I could pause you there and come back to you in a couple of moments.

Senator WHISH-WILSON: My questions are related to something you touched on before I had to leave the room previously. The minister made a comment in the media yesterday, I think, that DMO should focus more on Australian made products. Do you have an official local procurement policy at DMO for Australian products and services in contracts?

Mr King : I think it is far more complex than you can express in a simple policy. From Defence's point of view—certainly from my point of view—we know that we need a vigorous and competent industry to support our products and to support our services. Somehow it seems to be portrayed that that is not the case. It is very actively the case, but that always has to be traded off. When I say traded off, it has to be considered against other drivers, not the least of which are affordability and effectiveness. The example I used earlier today in response to a question was: we would not contemplate making a C17 type aircraft here. That is quite clear. Everybody can see that you would not do that. But, as you come down through the spectrum of what might be a capability in Australia, well within the means of Australia, or even a capability we want to set up in Australia, it becomes much more involved, with the number of factors that are taken into account that decide whether or not you will have an Australian supply or not.

Just to be clear, 60 per cent of our sustainment work is in Australia and 40 per cent of our acquisition work is in Australia. AWDs, for example, are being built in Australia. There are nearly 3,000 people working on them. It still only gets up to about 50 per cent Australian content. The reason is, of course, that we do not make gas turbines and we do not make five-inch guns.

Senator WHISH-WILSON: I suppose I was just interested in whether there was something solid in terms of policy.

Mr King : Not in that sense. For example—and this has happened—if Australian industry can only offer a digger a lower quality product and we need to give that soldier the better quality product to protect their life, you can bet where we are going to go with that decision. You can bet where we are going to go with that decision, but we could not sort of capture that in a detailed analytical policy that you could apply to any single procurement. But I say again: just over half our money is spent in Australia. We know that we have to maintain, support and use this equipment—so it is not passive.

Senator WHISH-WILSON: I accept it is not passive. My concern was actually that you might have some sort of formal policy but, under free trade agreements we are negotiating at the moment, that sort of procurement policy will not be possible.

Mr Richardson : Senator, I might just repeat something I said earlier in the day. From where we sit we seek to make the Defence dollar go as far as possible in terms of ADF capability. If we have a dollar to utilise, it is how that dollar can be best utilised to make the ADF as capable as possible to serve the national interest. We put forward options to the government. Every government, that I am aware of, will always bring into play at some point the domestic considerations. We do too, at a certain point—for instance, if we are buying the Joint Strike Fighter we have an MOU with Lockheed Martin in terms of what work might be available to Australian industry in the global supply chain, even though there is not a guarantee there.

When we look at ships being built, we look at the options: building in Australia, hybrid build, building overseas et cetera. We will put those options forward but, from where we sit, we give priority to what will serve the ADF and, through that, Australia's national interests. Government will obviously bring into play industry and other considerations, and that is legitimate, but we do not start off from that point.

Senator WHISH-WILSON: Fantastic; thank you very much.

Mr King : Just on the free trade issue, if I could: it is important that what we have done is to actually get a carve-out so that we can have Australian industry capability plans in our projects that we direct that we want done in Australia.

Senator WHISH-WILSON: Have you had negotiations with DFAT concerning that?

Mr Dunstall : There is express provision in annex A to chapter 15 of the Australia-US free trade agreement that specifically provides for the continuation of the Australian industry capability program. We mirror that market exemption in our free trade agreements for consistency.

Senator WHISH-WILSON: So that has been put on the table for the TPP and the Korea free trade agreement?

Mr Dunstall : I would have to check with the Department of Foreign Affairs and Trade, but we take a consistent approach with our free trade agreements on our market access arrangements.

Senator WHISH-WILSON: If you could check that for me, that would be fantastic. Thank you.

CHAIR: Senator Fawcett has some questions.

Senator CONROY: Sorry, I paused Mr King halfway through an answer. Senator Fawcett, I am happy for you to follow up on that if it is the same topic.

Senator FAWCETT: Yes, it is the same topic. Mr King, you mentioned in that answer the global supply chain. Could you just tell us: how many companies in Australia benefit from that approach? Is it 50 per cent, five per cent—what percentage of the industry benefits? I am happy to take this on notice so that Senator Conroy can keep going, but I would like to know how many companies are primes versus SMEs and what is the value of work that is going into the global supply chain for our companies.

The second point I would like to follow up on goes back to Senator Conroy's questioning. He asked a question and you gave the response that it did not cost extra for the re-baselining of the AWD program. Can I just clarify that the re-baselining did in fact incur a cost but that cost was absorbed by—depending which way you want to call it—the management reserve or the contingency and so, yes, the program did not need any additional money from government but there was a cost associated with the re-baselining.

Mr King : No, Senator, that is not right.

Senator FAWCETT: That was the evidence given by Finance in November estimates last year.

Mr King : I don't know what evidence they gave, Senator, but that is not right. What happened was that there was an accruing risk that was growing because of trying to meet the schedule. There were actually additional costs accrued because of the schedule but that was offset by reduced risk. There was no draw-down on MR because of that. That is the advice I have from the alliance.

Senator FAWCETT: Can I ask you to go back and check the evidence provided by ASC and Finance last year, because that is not the advice I was given.

Mr King : I will certainly check, Senator, but though this information I had from the alliance. I specifically asked for that advice, and the alliance is a holder of the global picture, but I will certainly check, absolutely.

Senator FAWCETT: Thank you.

Mr Dunstall : On your supply chain question, the top-level stats are that since the program has been operating effectively since 2009, although we did a pilot with Boeing in 2007, 390 contracts have been awarded to 86 companies with a total value of $590 million from a Defence investment of $36 million into the program. That is to date. They are the top-level numbers. I can provide more detail if you have specific questions.

Senator FAWCETT: If you can provide more detail on notice—

Mr Dunstall : They are all Australian SMEs.

Senator FAWCETT: in terms of the breakdown and whether that was overall value of the project versus the profit, the return to the company that was made. Any detail you can provide would be good.

Mr Dunstall : I will do that.

Senator CONROY: Mr King, you just finished explaining to me the internal risk assessment and how you came up with various numbers. I asked you to pause just as I think you had completed that part and then I think you were going to move on.

Mr King : Thank you for recapping, Senator, because a man of my age and under this pressure I need that sort of help. That was the way the target cost estimate is struck and of course the Commonwealth, because of this alliance, has a commitment to meet our share of the costs. As I say, I do not want to get ahead of the independent review; clearly there are eminent people to do it. But there are two factors that contribute now to what we think the cost of that ship construction will be. One is that the actual cost of work performed is exceeding the planned cost of work performed. I think you misunderstood what I was saying. There are real costs being incurred at the moment that exceed what we planned.

Senator CONROY: Material? I am using that in the commercial legal sense of the word.

Mr King : I guess it is material, yes, it is. Unfortunately in projects as big as this small percentage is a significant amount of money. So yes, it is. The other thing that worries me is the trendline. It is not unusual in a project to have periods where things do not look as good as they might and you look at your opportunities and risks and you structure things. But the difficulty at the moment is that the trend does not seem to be improving, so there is this problem with that. The second element is looking ahead, that in two cases there is the evaluation of the risks that might lay out there. Clearly they are not real costs yet but they are looking wisely looking ahead to see costs that you might incur or risks that you might meet. The third element that will be have to be addressed is that to continue to operate reasonably within budget will need to mean improved efficiency out of our project. So that also has to happen, not just status quo but actually improved performance.

Senator CONROY: I am familiar with large projects and changed assumptions and risk profiles where people suddenly decide you cannot possibly have learned anything in the early stages so we will just factor in a whole bunch of new stages. I suspect you are about to encounter the same.

Mr King : It is not quite huge, can I say. It is a significant amount of money, one that you cannot blink at, but it is not—

Senator CONROY: I started off understanding where you are going with material, but large dollar figures do not necessarily represent a material increase. It is usually characterised in a percentage, which avoids a silly conversation about a large dollar figure being considered to be immaterial. So I appreciate you are trying to avoid the perception that you would say that —I have no idea, so I am making a number up—$500 million is immaterial because the project is $10 billion. It sounds like a lot of money, but it is not a material item overall. So I appreciate that you are trying to navigate your way through that issue.

Mr King : That is correct.

Senator CONROY: What is the expert committee's remit to examine? It is looking at this new increased—

Mr King : The whole project.

Senator CONROY: It is looking at the overall project.

Mr King : It is looking at the whole project and assessing where it is, the progress it has made and any recommendations for how to complete the project.

Senator CONROY: So the budget is actually still the same. Has the contingency fund changed since the election?

Mr King : No.

Senator CONROY: Has there been any change to the contract with the prime vendor since the election?

Mr King : No, but I will take that on notice. We do do very small contract amendments, but nothing of any significance.

Senator CONROY: Have there been any changes to the contracts between the prime contractor and subcontractors?

Mr King : There might have been between ASC and the module builders in the allocation of modules, but nothing more significant than what you would think is in the normal process of building a ship.

Senator MADIGAN: Recently, Brobo Waldown and Parken Engineering both tendered to Land Systems Division to supply the ADF with 250 bench-mount drills. I have personally used both Brobo Waldown and Parken drills for many years and own quite a few pieces of their equipment. People in industry recognise that both these companies provide an extremely high quality product of accuracy, longevity and reliability. Can you please outline why Chinese products supplied by Hare & Forbes Machineryhouse were selected as the preferred product?

Mr King : Sorry, what were the supplies?

Senator MADIGAN: The suppliers were both Brobo Waldown and Parken Engineering—two Australian companies.

Mr King : But what was the equipment we were purchasing?

Senator MADIGAN: The company that supplied them with a Chinese product was Hare & Forbes Machineryhouse.

CHAIR: I think they want to know what the equipment was for.

Senator MADIGAN: Two hundred and fifty bench-mount drills.

Mr King : We will have to take that on notice.

Senator MADIGAN: Could you also tell me what the benefits of chosen drills were and what the deficiencies of the Brobo Waldown and the Parken products were?

CHAIR: You can take that on notice as well.

Senator MADIGAN: In a letter to the minister last week, Brobo Waldown stated that the specifications of the machines requested by the DMFO within the tender were a direct copy of the specifications of their standard machines. Is this statement accepted to be correct according to the department? Can you also take on notice what the proven longevity of these new Chinese imported drills is? Lastly, can you explain how it is best value for money to buy drills from China for less cash up front that will be need to replaced more often than the Australian product?

Senator Johnston: You have raised issues that concern me. I have not seen your constituent's letter. We will come back to you with a full explanation about the basis of the matters that you have raised. We have a time frame to do that.

Senator CONROY: Mr King, on 8 October 2013 it was reported in News Limited papers that the defence minister had called for two fresh briefing papers on the AWD project and the so-called valley of death. Can you confirm that these briefing papers have now been provided to the minister?

Mr King : I would have to confirm—

Senator CONROY: I think he is nodding.

Mr King : We have provided—

Senator Johnston: I think there have been more than one or two. I think there have been several.

Mr King : And discussions, of course.

Senator CONROY: Sure. Are they public documents? Is it possible for them to be made available to the committee?

Mr King : No.

Senator CONROY: Are we able to say with certainty that the government has ruled out the acquisition of a fourth air warfare destroyer, Minister?

Senator Johnston: At this stage I think we can say that, because we simply do not have the money for that. The white paper will deal with that issue, in my anticipation, but at this stage we are focusing on the three ships and trying to get that right. That is why I announced this review yesterday. I want to get that right so that we have some long-term capacity to go forward. But as of now the policy is no. We certainly do not have any new money for a fourth ship.

Senator CONROY: Thank you. At the Australian Defence Magazine conference, which I think was yesterday—

Senator Johnston: Yes.

Senator CONROY: Senator Johnston, you announced the establishment of a review of the AWD program, to be jointly led by former US Secretary of the Navy Professor Don Winter—

Senator Johnston: Don Winter, yes.

Senator CONROY: and former Transfield chief Dr John White.

Senator Johnston: Dr John White.

Senator CONROY: This review is to report to government in mid-2014, I think you announced.

Senator Johnston: In three months.

Senator CONROY: Does the government intend to take any action regarding the AWD project prior to the conclusion of that report?

Senator Johnston: We are constantly surveilling and offering advice to the construction team about matters that concern us, and we will be looking exclusively to the report from Professor Winter and Dr White as to, firstly, what the potential problems are and what the remediation and recommendations going to the remediation are. Then I can assure you that we will be following through on those recommendations.

Senator CONROY: Just to confirm, it is possible, because of that constant surveilling, that something could change prior to the completion. You do not intend to, perhaps, but—

Senator Johnston: In the wonderful world of commercial solvency, in work and in the employment of people, anything can happen, but at the moment things are reasonably stable. But there are concerns. That is why we have the review going. We want to take the advice. Professor Winter is, seriously, one of the experts in the field from an international perspective. Accordingly, we want to get his perspective before we go forward.

Senator CONROY: Thank you.

Senator FAWCETT: Mr King, could I take you back to a conversation we had at, I think, the last estimates or possibly the estimates before about LAND 121 phase 3B. I will preface this by recognising that Defence is not there just to hold up industry; you are about capability first. But the reality is that decisions of government do impact on defence industry, and in South Australia we have had companies go into liquidation—not necessarily purely because of this, but it has certainly been a large one of the sticks on their back. So I am keen to understand some of the things that have driven government decisions that have had a big impact on industry. The answers that were given at the last estimates about the 35 per cent Australian industry that the then minister committed to said:

… certain requirements forced Army to make some basis of provisioning changes…

What were those requirements?

Mr King : On the number of modules, the basis of provisioning and the affordability of the project, the fundamental reason for selecting the option we selected was that it gave the most capability to Army for the money available. In the adjustment of the basis of provisioning, the number of modules that were required was reduced, and the modules were an area where there was a high Australian content. I think that is right, General. But that was part of the decision-making process. The companies' offer and the amount of Australian content that they have to deliver is now locked in, but that was the reason for the change of that percentage.

Senator FAWCETT: So was that a decision driven by DMO or driven by Army in terms of what represented best value for money?

Mr King : It was driven by Defence and government approval for the project.

Senator FAWCETT: But this occurred after the preferred tender announcement and before contract signature?

Mr King : That is correct.

Senator FAWCETT: How many modules were not brought on board, and was anything else brought on board as part of that trade-off?

Major Gen. McLachlan : I do not have those numbers right in front of me, so I might take that particular aspect of the question on notice.

Senator FAWCETT: What type of modules were reduced in number?

Major Gen. McLachlan : There are a range of modules. I could not tell you exactly what they are at the moment, so I would prefer to take that on notice and give you the factual information.

Senator FAWCETT: One of the questions we had last time was that there was some concern expressed in industry that some of the production that was counted as Australian industry involvement was going offshore. I noticed that one of the companies on the list is doing heavy flatrack ISO 1C but not the standard pallets. Were the numbers of those standard pallets still maintained but sent offshore?

Mr King : We do not count offshore production that comes through an Australian subsidiary. We do not count the production and we do not count the profit on it.

Senator FAWCETT: I understand that but what I am getting at is in terms of DMO driving for what it considered to be best value for money over that 12-month period beyond when industry expected the contract to be signed, was the production of those modules, which are now not considered Australian industry involvement, sent offshore as part of that process because that was the only way the company could meet the cost targets that the DMO was setting?

Mr King : I do not believe so, but to be accurate I will need to check. If the proposal is that we did something to drive stuff offshore, I do not believe so.

Major Gen. McLachlan : Certainly it was never our intention for any of the flat racks to be manufactured in Australia, and consequently they were not considered as any part of any AIC calculations.

Senator FAWCETT: With the extended contract negotiation period, which I believe was in excess of 12 months, was there any adjustment to IOC for the project and if not is there an elevated risk in terms of delivery because of the pursuit of value for money?

Mr King : No, there was not any shift of IOC but, just as a pragmatic project manager, clearly that chews up some of the flexibility and so there must be, intuitively, some increase in risk, but we are driving to that IOC.

Senator FAWCETT: I notice in the industry plan on DMO's website that three of the four Australian companies who are indicated as participating are still noted as in contract negotiation. Do you have an update on where they are at?

Major Gen. McLachlan : Rheinmetall are currently finalising negotiations with the subcontractors That has not gone as well as we could have wished, and the latest advice we have is that we expect that negotiation with the subcontractors is likely to be finalised by March. The subcontractors that are engaged at this point in time include Marshall Land Systems from Victoria, Liquip International from Victoria, RPC from New South Wales and Sea Box in the ACT. Thales has also been engaged to undertake the initial design work for the integration of the C4I suite. That is the current update as we see it, and the remaining subcontractors are expected to be engaged in March.

Senator FAWCETT: One of the concerns I have is that if DMO's pursuit of the lowest possible price—to use your words, Mr King, stretching the dollar as far as you can go—drives a prime to put onto its suppliers, its SMEs, conditions that are almost unviable for them, there is obviously a reluctance for them to agree. Is that one of the factors that are causing this delay in those contract signatures?

Mr King : Having spent 20 years living that life, I expect it is. But that is the lift of industry. If the proposition is that we placed beyond reasonable pressure on them and therefore made it unviable, I do not agree. But if the proposition is that we seek to get the best value and that has knock-on effects, yes it does—and no doubt in this case it has done that to some extent. Our understanding is that they are close to agreement—and I have to be careful here because now I actually start playing in their business environment if I say too much.

Senator FAWCETT: I am encouraged to hear that. But, given again that the IOC is fixed and it is not moving, do these delays mean that we have missed any of the critical milestones in the project schedule?

Mr King : We have missed the IBR because of that, but that is not the first time. We had another recent truck program by another reputable company that missed the IBR too.

Senator FAWCETT: Mr King, I am not in the game of trying to compare companies and I am aware that there is a lot of discussion in industry with different companies putting forward information. I am concerned about the government's conduct that, on one hand, yes, we have to get good capability and we should maximise the value of the taxpayers' dollar but we also have to be a model partner for industry that does not unnecessarily drive industry into positions where it damages individuals' health and careers and companies go into liquidation.

I am not about taking sides with the industry players. I am not about trying to say that you should have taken that bid versus another bid. I am interested in the process and the culture within our procurement process that has a direct impact upon the ability of Australia's industry to be sustainable and viable.

Mr King : I will just respond in a couple of ways. Any inference that we are not a model customer and that we do that is wrong. It is just wrong. I have been involved in any number of major projects where we have fully taken into account all sorts of aspects to make sure that Australian industry stays in projects. This is no less a case. We took a valid and viable offer from a world renowned company. That certainly has pressures in it and it has been difficult for them to line up all solutions at the right cost. But there was nothing unconscionable or unreasonable about what we accepted or anything we have changed since accepting it that would have forced that on Australian industry.

Senator FAWCETT: I also hear your point that it is not the first project. In fact, another project—who I believe is probably a competitor—also missed milestones.

Mr King : He did a great job.

Senator FAWCETT: Is my understanding correct that that milestone should have triggered a project of concern label for the project?

Mr King : No. We do not use that for project of concern.

CHAIR: We will have to wrap up at this point. We are almost five minutes over time. I would like to thank everybody for being here today—the minister, Mr Richardson, secretary of the department, General Hurley, the DMO and all the other witnesses and supporting staff.

Proceedings suspended from 18:33 to 19:31