Problems with Naval Ship Procurement?

Radio Canada’s le téléjournal ran an investigative report Tuesday and Wednesday on naval ship procurement.  The opposition parties are claiming that government incompetence could lead to massive overspending under the National Shipbuilding Procurement Strategy.  The Radio Canada report uses the Joint Support Ship (JSS) project as an example to assert that the government underestimated the inflation rate in cost estimates, and that the inflation rate is the principal risk factor in warship procurement.  The reporting misses the mark.

The problem with the debate that is currently occurring in Parliament and reflected in the press is a lack of informed opinion.  Developing good cost estimates for building warships in Canada is difficult.  The inference that naval warship procurement is another F-35 debacle waiting to erupt is simply unsupported by evidence.

We face a real challenge predicting the cost of constructing warships in Canada that, on the surface, may seem similar to the problem with the F-35, but a more considered review would show that the only similarity is predicting the final cost of military equipment before design and development is complete.

Matching the available budget with an affordable capability is the procurement ‘dance’.  Decisions start with ideas, concepts and notional costs.  Governments have a habit of making large procurement announcements for political reasons.  Unfortunately, in the case of shipbuilding projects, the announcements may appear to be definitive when ships are at early concept level and only initial budgetary cost envelopes are available.

The public perception that everything is decided and well known sets up unrealistic expectations.  In fact, the opposite is the case, very little is known about the design and any associated costs.  Professionals understand that these early cost estimates could vary by as much as 40 percent.  The real test of an estimate occurs as the design progresses, the requirements are fixed, and industry is requested to respond with an offer.

Ultimately the final test of the estimate is the cost proposed by a shipyard.  Our procurement process was designed with an underlying assumption that transparency and fairness is important.  It is also based on the ideology that competition will unleash human ingenuity to find the best solution to any given military requirement.

So how does inflation play into this process?  The longer it takes to make a decision the less a fixed budget will buy.  We know that over the past decade the fixed budget of the JSS has lost 33 percent of its buying power just because of inflation.

Radio Canada claims that the inflation in the shipbuilding sector runs 7 to 11 percent and that the difference between this rate and underlying inflation somehow indicates incompetence.  Inflation figures are easy to criticize retrospectively.  The 7-11 percent quoted by Radio Canada is similar to the figures in a report by the RAND Corporation for the USN (available here), which identified that over the past 50 years in the United States, the cost of a surface combatant increased at about twice the inflation rate.

The higher inflation figures were attributed to two basic causes: replacing older ships with more capable ones for the same missions, and indirect influences such as higher environmental and safety standards in construction.  Applying the conclusions of this report to Canada makes two big assumptions: first, that we buy warships using a process similar to the United States, and second, that the RAND conclusions for ships with state of the art complicated and costly weapons systems would apply to the Joint Support Ship.  These assumptions make little sense.

In the bigger picture, the problem with our naval ship procurement is not inflation.  It is our ability as a nation to understand the requirement and the reasonable cost of that requirement.  Early cost predictions are by their very nature estimates.  How reasonable is it to expect a government to be able to predict the cost of a new warship when the best comparable Canadian cost information is over 20 years old?

The greatest risk is our ability to estimate the real cost of capability when we buy military equipment; this was at the root of the failure of the first JSS procurement.  No one, not the government, the navy, or the contractors knew that a solution to the requirement was unaffordable before the effort to develop a solution took place.  This is one of the key issues that the National Shipbuilding Procurement Strategy should be able to address.  Rear-Admiral Patrick Finn summarized the issue in his reply to Mr. Tom Ring on the National Shipbuilding Procurement Strategy at the November 22, 2012 meeting of the Standing Committee on Government Operations and Estimates (available here):

One of the outcomes of the [National Shipbuilding Procurement] strategy … is the bilateral engagement it has created. Historically we would have tried to do many of these very complex acquisitions in a competitive environment, where it is very, very difficult to have any kind of dialogue between the competitors to get to what I would call 'ground truth' for costs.

The real risk is not a misapplied inflation rate; the challenge for the government is establishing budgetary cost ceilings for a warship, or the capability that a warship represents, before even a design is known.  One of the main roles of the procurement organization is to manage that risk.

The real dilemma in this debate is the expectation by everyone involved that government and industry are able to know the cost of a warship accurately at very early stages of design.  These expectations are almost preplanned resentments, as the capability and cost relationship begins to come into focus.  Rear-Admiral Finn explained this in reply to Mr. Denis Blanchette during his testimony at the Standing Committee on Government Operations and Estimates on 22 November:

Usually, a spiral process is used in ship design. Budgets are set. We know very well that the opportunities to surpass and increase those budgets are very limited. So the process will entail changing the design and reviewing the needs—repetitively and in co-operation with the yards—to be able to ultimately deliver ships within the set budget.

Whenever the government decides to buy a new ship or class of ships it may need to adjust requirements to match available funding.  It is also possible that requirements are so important that provision will be made to increase the funding.

Inflation is not the problem.  The procurement process is not broken.  It is just a very challenging task to provide accurate costs of naval capability before a ship is even designed.