Following the implementation of the Defence Reform Act (the Act) and the Single Source Contract Regulations 2014 (the Regulations), we look at the first compliance report from the Single Source Regulations Office (SSRO), which covers the SSRO's monitoring period from 18 December 2014 to 31 December 2015 (the Period).
Any new regulatory framework will take time to settle down, especially given the complex landscape of the UK defence market.
The headlines of the report are:
- the number of Qualifying Defence Contracts (QDCs) has been lower than the SSRO anticipated (Marcine Waterman, Chief Executive of the SSRO expected 50-60 QDCs in the first year and there have been 17 QDCs and 1 Qualifying Subcontract);
- the Regulations and SSRO's guidance have been subject to differing interpretations;
- there are disagreements over the level of detail required to satisfy the inclusion of costs and the contract profit rate which the SSRO finds challenging when assessing compliance; but
- on the upside, the framework is beginning to deliver savings (although very modest); and
- defence contractors and the Ministry of Defence (MOD) have been willing to remove non-Allowable Costs identified by the SRRO.
Clarity and Understanding
In the report, one of the key areas identified for improvement is the SSRO's acknowledgement of the differing levels of understanding of the Regulations/the SSRO's guidance among contractors and MOD staff. There must be concern about how long it will take to obtain clarity and an equal understanding across industry.
While a proactive application of the SSRO Operational Working Group, the SRRO helpdesk and SSRO question and answer sessions will help to create more certainty and understanding, perhaps the Operational Working Group meetings need to be held more frequently and openly, and any SSRO clarifications circulated more widely across industry and the MOD?
Is more focused training required to MOD and contractors?
Savings
The framework is beginning to deliver savings with £100,000 of agreed savings reported during the Period. This figure is arguably disappointing given the scale of the defence market; however, a further £5.7 million of possible savings are under investigation on the six QDCs, each with a value in excess of £50 million in the Period.
In addition to this, there are further potential savings estimated to be in excess of £20 million. This is encouraging data given the aim is to secure value for money for the taxpayer balanced against delivering a fair return to companies delivering defence equipment and services.
Allowable Costs
The SSRO has issued guidance on a range of costs that are not Allowable and the SSRO has already achieved success removing such costs from the relevant contracts. Parties should now be familiar with the concept that the cost of rework will only be Allowable if it is Appropriate, Attributable and Reasonable (AAR), is agreed between the MOD and the contractor, and that any rework arising as a result of faulty workmanship is generally not Allowable.
The report also highlights that the inclusion of costs in a Questionnaire: Method and Allocation of Costs (QMAC) does not make them Allowable and that this has been successfully highlighted to a number of contractors. Costs will only be Allowable if they meet the AAR criteria.
The report highlights issues around indirect costs and where they are Allowable, particularly due to delays between the parties agreeing the overhead rates and contractors failing to evidence the split between the direct labour rate and the indirect rate, and the analysis of overheads or calculation of overhead recovery rates.
The SSRO has sought clarification from contractors and found QDCs non-compliant in the absence of evidence that costs meet the AAR criteria. Clearly, the SSRO is strongly asserting the position on Allowable Costs.
Contract Profit Rate
The SSRO has an important function to scrutinise the figures and calculations used to determine the contract profit rate for pricing QDCs and assessing if a QDC report submitted by a contractor complies with the SSRO contract profit rate guidance.
It is apparent that, to some extent, the SSRO has been hampered in performing this role due to a lack of data being provided. The SSRO will continue to push for relevant information to ensure contract compliance with the Act and Regulations.
The use of provisional rates rather than agreed rates in QDCs which have already commenced is another issue identified in the report and, although it is acknowledged that this may be to deliver defence capability quickly, the SSRO is aware that such an approach compromises its ability to assess compliance with the Act and Regulations.
These issues must be addressed as they are at the heart of the framework and we wait to see what changes the SSRO can bring to these contracting practices.
Conclusion
The findings of the report show progress, particularly on the difficult issue of Allowable costs, and although the report identifies teething problems which are fairly acknowledged by the SSRO, one may agree with the outgoing Chair of the SSRO when he says that: "it is already clear that the new regime has the potential to achieve substantial savings which can then be reinvested elsewhere in defence."