Sector News
Single-Source Procurement in the Military Sector

Anyone involved in public sector procurement should have a number of fundamental beliefs. Right at the heart of those should be the principle that competition is the most effective mechanism to arrive at a fair value-for-money agreement between a buyer and a seller.

Competition drives suppliers to be more effective, it encourages innovation, and enables buyers to pay a “fair” price. Indeed, this all applies to the private sector buyer just as well. For most of what the public sector buys, competition is possible – it may not be perfect, but there is some level of competition. However, in certain cases, competition may be difficult, inadvisable or even impossible.

Military and security matters are an obvious example. The lack of competition may come from a pure lack of suppliers in that field, or it may relate to national security issues where a country wants to preserve a supplier (but perhaps only one) in a particular area. So the UK now has only one shipyard that can maintain nuclear submarines, for instance – and that has been true for some years now. That poses a problem for the government and the buyer. How can the taxpayer be sure that a fair price is agreed when competition can’t be used to drive that?

In the UK, the military issue has been addressed via a set of policies and rules for “single source” procurement. That is now being overhauled and reviewed by a new organization set up in January this year, the Single Source Regulation Office (SSRO).

In general terms, suppliers have been allowed to make 10.6% profit on top of their costs (so a “cost plus” arrangement), a figure calculated based on an average of profits earned by a selection of UK listed businesses. But there have been ways in which that could be even higher – contractors can charge significant further “contingency” costs, for example. There are also issues around what are allowable costs that can be counted .

For instance, in a recent speech, Defence Minister Michael Fallon claimed that a “lack of commercial leverage” and “information” allowed contractors to claim for costs including croquet, horse racing trips, motoring fines, and “close-up magicians”. Now we don’t know the detail of this but we can probably take Fallon’s comments as part of the political and negotiation positioning for the new rules! IT does suggest though that the process does leave room for some abuse.

The Chairman of the SSRO is Jeremy Newman. In a recent interview with the Financial Times, he said that “the world has changed since 1968 and we need to start looking at things differently”. He suggested that the percentage margin might change.

“Back in the ’60s and ’70s, the Ministry of Defence’s buying was much simpler. The profit benchmark against manufacturing made a lot of sense. Today they buy a whole range of goods and services, a whole host of different sorts of contracts, some of which bear little resemblance to industry and manufacturing. The world is also a lot more global.”

However, like many changes, it seems there is some resistance, perhaps from both the supply side and the MOD itself.

“Just three of 61 single-source contracts awarded this year have fallen under the SSRO’s remit because the others were classified as extensions or amendments to existing contracts, Mr Newman said. It’s far less than we were expecting . . . but we anticipate it will change in time. The longer it takes you to transition to the new regime the longer you are losing out on the benefits.”

In time, the government hopes that all £8bn of its annual spending on single-source defence contracts will be overseen by the SSRO. The aim is to save the taxpayer at least £200 million, but the feeling is it could be much higher. There is some evidence that companies have been earning anything between 12 percent and 22 percent margins, Mr. Newman said.

The new proposals will be put out for consultation on September 25th, and we will wait for those with interest. They are likely to suggest scrapping the contingency allowance, tightening up the processes around what are allowable costs, and stopping the process of charging profit at multiple stages of the contract.

However, the fundamental problem remains for every country and public body that works in this sort of market. Without competition, how do we know whether these are value for money contracts? Reducing the allowed margin from 10.6% to maybe 8% would obviously have some benefits to the taxpayer – but if that is charged on costs of £10 million when really a fair price would have been £5 million, there is still a real problem.

There is no easy answer to this. Could the SSRO get into detailed cost modeling and analytical work to establish whether prices are reasonable? Could they benchmark against other countries who may be buying similar items under their own single source agreements? And above all, are there ways to reduce the amount of goods and services that are single-sourced? Otherwise, we have a nasty feeling that the creativity of the private sector providers will find a way around and through any new measures that the SSRO may introduce!