Rolls-Royce row: could a weak UK defence budget force a British icon to leave the sector?

Rolls-Royce has warned that continued pressure on the UK defence budget could force the company to reduce investment in its highly-skilled defence workforce, with a worst-case scenario of the company pulling out of UK defence sector altogether. The heavy-handed warning did, however, come hot on the heels of a government review of whether or not the company overstated costs on a Hawk trainer contract. So does the threat hold weight? Claire Apthorp reports.


red arrow

In December 2015 Rolls-Royce was awarded a £79m contract by the UK Ministry of Defence (MoD) to support the Adour engines used by aircraft flown by and for the Royal Air Force and the Royal Navy.

The five-year MissionCare contract covers support for the two Adour engine variants used on UK aircraft: the Mk951 that powers the BAE Systems Hawk TMk2 advanced jet trainer used to provide fast jet training services under the UK Military Flying Training System (MFTS); and the Mk151 variant that powers the Hawk TMk1 or Red Arrow aircraft flown by the Royal Air Force Aerobatic Team and used in a variety of training roles with the Royal Air Force and Royal Navy.

Rolls-Royce’s contract covers support to all UK main operating bases and repair and overhaul services, with the goal of maximising the number of engines available to power training missions, in order to drive higher levels of customer capability. Chris Cholerton, president of Rolls-Royce's  defence division, said at the time of the contract award: “The solution was developed in a partnered approach between Rolls-Royce and the UK MoD, ensuring that we meet the operational needs of the training fleet while providing value for money for the UK.”

However, in May the Single Source Regulations Office (SSRO) threw this value for money claim into doubt. The SSRO is a new independent regulatory body set up to ensure that the UK MoD is getting the best possible value  out of its single source procurement and support contracts. Single source contracts account for a significant proportion of the contracts under which the MoD acquires and supports its equipment – in 2014/15, they represented around 53% of new MoD contracts, amounting for around £8.3bn. As a result, ensuring the MoD – or taxpayers – receive value for money here is paramount.

Questioning value for money in defence contracts

The SSRO issued its first formal determination on whether the MoD was getting this value on the Rolls-Royce contract in May 2016. Following a review on what costs are appropriate for a contractor to pass on to the taxpayer - led by a panel of two of the SSRO’s non-executive members and an independent member and evidence from the company and the MoD - the SSRO investigated the extent to which sales and marketing costs could be included and whether the level of cost adjustment for risk was appropriate.

"The SSRO decided that the company was overstating the risk of future cost variation."

For the first issue, the SSRO decided that that Rolls-Royce had not established a clear link between some of the costs being claimed and the contract in question. On the second, the SSRO decided that the company was overstating the risk of future cost variation and should not be adding the 25% adjustment it proposed.

In a statement issued at the time, SSRO interim chairman Clive Tucker was quoted as saying: “The law is very clear that the onus is on the contractor to justify the costs it wants to pass on to the taxpayer. We published detailed statutory guidance on allowable costs at the start of 2015 and contractors have normally been willing to remove any non-allowable costs we identify. However, this binding determination shows that if contractors won’t adhere to the guidance we have the ability and the will to impose a change when necessary. With regard to this particular contract with Rolls-Royce, it is a matter of continuing concern to us that there are further compliance questions to resolve.”

Is the government's penny-pinching going too far?

Rolls-Royce pushed back on the ruling, with the company’s CEO, Warren East, quoted in an article published in The Manufacturer in August as saying that while taxpayers’ money must be spent wisely, the government still has to be careful not to allow penny-pinching to start eating into Rolls-Royce profits.”We need to get a bit smarter and not use a sledgehammer to crack nuts,” he said. ‘If we don’t make sufficient profit on doing defence work then we are not going to invest in the skills necessary to deliver a good solution, and ultimately we’ll end up withdrawing from it. From a national point of view, you’d have to question whether we want out defence industry to wither on the vine. That’s not a good idea.”

He added: ”The government money is very useful, but there are governments around the world who are very keen to support us… Half our staff are in the UK and we are a UK headquartered company, but I have to remember the other half of the staff that are not in the UK, and the fact that for the next ten years three quarters of our business is outside the UK. If there are governments elsewhere that are able to help us get a better result, then we have to pay some attention to that.”

Securing the future of the British defence industry

So how does this reflect on the way the MoD and the SSRO are pushing for value for money across the board?”Value for money is vitally important but that does not mean the government also has a right to take only a short-term view,” says independent defence analyst Howard Wheeldon.  “SSRO has not only caused uncertainty and further damaged industry confidence; it is fast proving unworkable. The MoD and Industry need to work together, not as a ‘them and us’. Great progress was being made - whilst very few projects have actually been sent to SSRO, its inception has sent much of the good work done in improving  relationships and trust back to the drawing board.”

Furthermore, Rolls-Royce making noises about withdrawing from the UK defence market altogether does not bode well for the future of domestic aerospace manufacturing, particularly at such a critical time for the country's defence industry. Value for money for the taxpayer is vital, but must be taken in balance with the fact that companies such as Rolls-Royce are British technology leaders that need support from government to ensure innovation, technology and skills continue to be invested in for the future security of UK industry.”Rolls-Royce is right to fire a shot across the bows of government that it cannot afford to take on the burden of future investment in defence technology and skills retention if the government is intent to chopping it off at the knees,” says Wheeldon.

“There is no point in making an investment unless there can be envisaged returns. Industry knows far better than government what this requires. Placing profit level obstacles on companies that have an excellent history of investing in product, manufacturing capability, skills and people is not what any of our competitors do.”