- Hunter class frigates
Overview of the project
3.1The Hunter Class Frigates project arose from the Australian Government’s announcement in August 2015 that it was bringing forward to 2020 its plans to replace the Royal Australian Navy’s current fleet of eight ANZAC class frigates. The Department of Defence (Defence) planned to build the new frigates in Australia as part of the Government’s plan for long-term continuous shipbuilding, intended to develop a sovereign Australian shipbuilding industry and foster job creation.
3.2The frigate project was to be delivered in five stages:
1Competitive evaluation process to identify a designer and builder
2Design and productionisation
3Batch one ship build delivering three ships
4Batch two ship build delivering three additional ships, and
5Batch three ship build delivering the final three ships (nine in total).
3.3Defence began a shortlisting process for the frigate project in August 2015 with an initial market survey to relevant ship designs which met the essential criteria. These criteria included ships that would be buildable and supportable in Australia within the program budget, commence in 2020, and meet the Navy’s capability requirements. Defence used these criteria to shortlist three designs from an initial panel of seven for a further competitive evaluation process.
3.4The Government announced in June 2018 that it had assessed the three shortlisted designs in a competitive evaluation process and that the new frigates would be designed by BAE Systems and designated the Hunter Class. The selected design was based on the BAE Systems Type 26 Global Combat Ship design with Australian modifications. The key modifications were to integrate the United States Navy’s Aegis combat management system with a Saab Australian interface and Australian CEA Technologies phased array radar. The platform characteristics for the Hunter Class frigate design are graphically depicted in Figure 1.
Figure 1Characteristics and key systems of the Hunter Class Frigates
Source: Auditor-General Report No. 21 2022–23, Department of Defence’s Procurement of Hunter Class Frigates, p. 20.
3.5As noted in the Auditor-General’s report, the Government’s 2020 Force Structure Plan reported a cost estimate for these new ships of $45.6 billion upon delivery of the intended nine vessels. The audit report further noted that the acquisition of new frigates was a key part of the Government’s expenditure on maritime capability and a key contribution to the ongoing capability of the Australian Defence Force.
3.6Defence entered into a head contract with BAE Systems Australia (BAE) in December 2018 valued at $1,904.1 million. The contract covered the design and productionisation work for the Hunter Class Frigates (stage two). By March 2023, the value of the head contract had increased to $2,597.4 million. Defence planned to return to government to approve additional contracts under this head contract for the different ship build batches.
3.7The head contract committed BAE and the Commonwealth to work to develop a strategic relationship in accordance with a set of principles. This included developing a culture of open communication and transparency’ and ‘discussing all issues in an open and honest manner’.
The Commonwealth procurement framework
3.8The Commonwealth Procurement Rules (CPRs) are at the core of the Commonwealth procurement framework. The CPRs are issued by the Finance Minister under section 105B of the Public Governance, Performance and Accountability Act 2013 (PGPA Act), and provide the basic compliance framework for the Commonwealth entities subject to them in undertaking procurements. These rules apply to Defence major project procurements, including the acquisition of the nine new Hunter Class frigates.
Audit findings
3.9Auditor-General Report No. 21 2022–23 (the audit) assessed the effectiveness of the Department of Defence’s procurement of Hunter class frigates and the achievement of value for money.
3.10The audit built on previous work by the Auditor-General on Defence’s acquisition and sustainment of Navy ships and implementation of the Australian Government’s 2017Naval Shipbuilding Plan. This included performance audits, as well as the inclusion of the Hunter Class Frigate project, referred to as SEA 5000 Phase 1, in the annual Major Projects Report.
3.11The audit considered Defence’s:
- tender process
- advice to government on the procurement
- contracting arrangements
- contract monitoring and reporting arrangements, and
- delivery of project milestones.
- The audit found overall that Defence’s management to date of its procurement of the Hunter class frigates had been only partly effective:
Defence’s procurement process and related advisory processes lacked a value for money focus, and key records, including the rationale for the procurement approach, were not retained. Contract expenditure to date has not been effective in delivering on project milestones, and the project is experiencing an 18-month delay and additional costs due in large part to design immaturity.
3.13ANAO found in its audit that Defence did not conduct an effective limited tender process for the ship design, did not assess value for money for the three competing designs, and that the Tender Evaluation Plan did not include a requirement for this. These practices were not compliant with the CPRs or the Defence Procurement Policy Manual.
3.14ANAO further found that though Defence’s advice to Government on the approval for the Hunter Class Frigate project was timely and informative, its advice at the second pass approval was not complete. Defence did not advise Government that it had not conducted a value for money assessment, that it considered that Government would make this assessment, or that its Tender Evaluation Plan stated that Government would assess value for money.
3.15Defence’s response to these audit findings at that time was that it ‘ensures all procurement advice to Government on major acquisition projects includes the basis and rationale for proposed decisions, including value for money.’
3.16Defence was found in the audit to have largely fit-for-purpose contracting arrangements, although the contract management plan was established three and a half years after the head contract was executed. Notably however, ANAO reported that Defence’s expenditure was not effective in delivering on milestones for the Hunter Class Frigate project and that the cost of the head contract had increased. A lack of design maturity resulted in an 18-month delay to the project and extension of the design and productionisation phase, at an additional cost of $422.8million to the taxpayer.
3.17ANAO made two recommendations in the audit report, both of which were agreed to by Defence:
1The Department of Defence ensures compliance with the Defence Records Management Policy and statutory record keeping requirements over the life of the Hunter class frigates project, including capturing the rationale for key decisions, maintaining records, and ensuring that records remain accessible over time.
2The Department of Defence ensures that its procurement advice to the Australian Government on major capital acquisition projects documents the basis and rationale for proposed selection decisions, including information on the department’s whole-of-life cost estimates and assessment of value for money.
3.18ANAO also identified three opportunities for improvement, that Defence should:
- confirm all probity matters have been drawn to the attention of the probity advisor before obtaining final sign-off
- clearly map reported outcomes to contract negotiation directions and strategies, and
- prepare key contract management documents in a timely manner.
- Additionally, ANAO suggested further training and oversight might be required for Defence officials involved in major capital acquisition projects, and that there is scope for more active engagement with the Department of Finance in its role as the policy owner of the CPRs.
Committee’s inquiry
3.20On 11 May 2023, the Committee broadened the scope of its combined 2020–21 and 2021-22 MPR inquiry to also include a detailed review of the Hunter Class Frigate performance audit. The Committee made this decision as concerning issues were highlighted by ANAO in relation to this significant naval acquisition.
3.21The Committee focused its examination on several key issues in relation to the Hunter Class procurement processes:
- lack of value for money consideration
- advice to government
- poor record keeping
- lack of design maturity
- use of probity advisors
- capability of the new frigates, and
- Australian industry capability.
Value for money
Requirements under the current procurement rules
3.22When undertaking procurement activities and entity’s accountable authority must promote efficient, effective, economical and ethical use of public resources in accordance with the Public Governance, Performance and Accountability Act 2013 (PGPA Act) and the CPRs. Achieving value for money is the core rule of the CPRs irrespective of the type of procurement process undertaken. Responsibility for assessing value for money rests with officials under the CPRs, including processes where ministers are the final decision‑makers on procurement outcomes.
3.23The CPRs recognise that price is not the sole factor in assessing value for money and state that officials must consider relevant financial and non-financial costs. These can include the quality of good and services, flexibility of the proposal, environmental sustainability of the proposed goods and services, and the whole-of-life costs. This assessment also considers the benefit to the Australian economy.
3.24The Committee’s recent report on Commonwealth procurement raised a number of examples where value for money had not been demonstrated or prioritised in the procurement process and discussed the resulting issues that arose from this.
Issues relating to the Hunter Class Frigates
3.25Defence’s Request for Tender (RFT) for the Hunter Class frigates set out 10 evaluation criteria and other considerations, including value for money. Additionally, the RFT stated that the evaluation criteria would be used to determine the best option to ‘support the achievement of the Project Objectives on a value for money basis’.
3.26Defence developed and approved a Tender Evaluation Plan (TEP) for the procurement of the Hunter Class Frigates that was intended to be the ‘the planning and control document for the management and conduct of the tender evaluation’.
3.27This TEP set out the roles, responsibilities and processes to be followed in the evaluation. The TEP also stated that Defence did not need to evaluate and rank tenders based on value for money, and that its assessment would focus on the tender evaluation criteria which addressed capability, timing, project management and Australian Industry components, not pricing or value for money. The TEP stated that ‘it is proposed that Government will consider the value for money of the tenders’.
3.28The Australian Government Solicitor (AGS) signed off on the TEP, stating that it had identified no probity of legal process issues. AGS noted, however, that no value for money assessment was required, and that this decision would need to be made by some level of government which should be documented in the TEP.
3.29The audit indicates that earlier drafts of the TEP included a value for money assessment that was eventually removed. At the 19 May 2023 public hearing, Defence officials could not explain why this had been done. Defence further advised the Committee in a written response that it could not provide another example of a TEP where value for money was not considered, stating ‘this situation appears to have been unique [to the Hunter Class TEP]’.
3.30ANAO reported in the audit that Defence followed its TEP and that its evaluation report did not include an assessment of value for money. Senior Defence Committees considered the tenders and proposal before the three shortlisted tenders, with the Type 26 frigate design becoming the preferred option, went to government for decision. None of these Committees explicitly addressed value for money.
3.31In its ‘second pass’ advice to government to approve the preferred tenderer, Defence provided advice on its preferred capability, and the cost of the tender options, but did not include an assessment of value for money.
3.32The Department of Finance (Finance) informed the Committee in its supplementary submission to the inquiry that it has an ongoing role in assessing Defence capability proposals:
Finance reviews information provided by Defence in order to provide a view on whether the costs are reasonable, realistic, comprehensive and consistent with the proposal being presented to Government (similar to the process for assessing a New Policy Proposal, but without formally agreeing to costs). Finance also provides a Cost and Risk statement that is included in the relevant cabinet submission, which provides advice on cost quality, affordability and key risks of the project, as well as any mitigation strategies proposed by Defence to address those risks.
3.33Finance further stated that its role in the Hunter Class Frigate Program was to regularly engage with Defence on capability development leading up to the 2018 decision to select BAE as the preferred tenderer, and then prepare a Cost and Risk statement ‘which advised Government on key factors relevant to the consideration of value for money, consistent with Finance’s general role in advising Government on Defence capability proposals’.
3.34Finance indicated however that its Cost and Risk Statement advice was that ‘that the decision to select BAE was based solely on capability’ and further stated:
Consistent with Finance’s normal role in Defence capability acquisitions, Finance had no direct role in relation to the procurement process conducted by Defence and did not directly reflect on Defence’s assessment processes in its advice to Government.
3.35At the public hearing on 20 November 2023, Finance further commented on this specifically, indicating that it had reflected on the matter and would take a different approach were it to happen again:
In terms of the cost and risk statement that the Department of Finance puts together that accompanies any of these submissions going to government, as I said in May, we acknowledge that we didn't explicitly call out that there wasn't a value-for-money assessment… I think the key learning for us is that, moving forward, we've spoken about how I would hope we wouldn't be in this circumstance, but, if we were in the circumstance where that piece of analysis was missing, we would more explicitly call it out, rather than the way we handled it in this circumstance.
3.36In its response to ANAO’s findings on the issue of demonstrating value for money Defence stated:
Defence recognises that value for money is not solely determined by the price. The Government determined there to be value for money in establishing a sovereign, sustainable, cost-competitive continuous shipbuilding program in Australia. The tenders were therefore considered in line with the Government's policy around continuous naval shipbuilding.
3.37At the 19 May 2023 public hearing, the ANAO noted that Defence had conducted procurements in the past, such as the Offshore Patrol Vessel, which assessed and informed government of clear value for money assessments, comparisons, and rankings. The ANAO also noted that in other audits of Defence shipbuilding projects it had seen comparative value for money assessments in the advice to Government.
3.38During the course of the inquiry, Defence conducted an internal review of its Hunter Class procurement processes and provided its findings to the Committee in a supplementary submission. Defence made a number of observations in this review regarding its assessment of value for money:
- Defence did not appear to recognise how the incompatibility between the project objectives, including considerations relating to price and continuous naval shipbuilding, and the procurement method as described in the tender documents, would impact on Defence's ability to achieve value for money.
- Across the planning, shortlisting and down-select stages of the procurement, deficiencies in the process complicated the ability of Defence to achieve value for money during the course of the procurement and compliance with legislated requirements and Defence procurement policy.
- Defence did not use all information available out of the tender process to undertake a comparative assessment in a manner consistent with Defence procurement policy. In failing to do this, Defence did not fulfil the requirements of the Commonwealth Procurement Rules in relation to achieving value for money.
- Advice to the then-government at second pass in connection with the conduct of a value for money assessment was poorly executed by Defence.
- Issues concerning inadequate advice to Government during the Hunter Class procurement process are considered in the next section.
- Defence’s overall observations from its internal review findings were that ‘these matters in combination could have ultimately led ANAO to form their view in connection to Defence not fulfilling the requirements of the Commonwealth Procurement Rules in relation to achieving value for money’.
- The Secretary of Defence makes a personal remark in this same supplementary submission [signed by him] that:
I have noted that former Defence officials interviewed considered that there was sufficient advice provided to government to allow it to make a value for money assessment.
3.42At the public hearing on 20 November 2023, Defence informed the Committee that in the second-pass advice to Government, no explicit reference was made in the cabinet submission to value for money and that this should have been done. The Defence Secretary further stated at that hearing:
I accept that that was a deficiency, which we acknowledged in terms of the ANAO's report and for which we are putting in place some arrangements, but it is not correct to say that the issues of value for money and cost were not ventilated during that process. It was a process over a number of years, and during that time officials were engaging on issues to do with cost and the complexity of the project.
3.43On further questioning by the Committee as to whether Defence continues to stand by its formal response to the audit, the Secretary remarked:
…we have done subsequent work and further reflection, and we've looked more at the procedures. I believe that Defence failed to provide clear advice around value for money, which I believe that we should have provided and which the ANAO identified as a failing in our process.
3.44The Auditor-General commented during this discussion however, as highlighted in the audit itself, that ‘it was an active decision that the tender evaluation panel would not consider value for money. It wasn't something that was left out of the cabinet submission at the end; it was built into the tender evaluation process’.
3.45The Auditor-General further remarked at the 20 November hearing that none of the supplementary evidence provided by Defence to the inquiry altered the conclusions that were drawn in the audit. He stated:
I decided to include a large number of rejoinders to the department's response in this audit because, while it said some positive things, the tone of the response was generally to disagree with most of what the audit findings were, or the heart of them, particularly with respect to the value-for-money issue and also with recordkeeping, where the response tried to minimise that, saying it was only a couple of documents that weren't available… Then the department does a review and comes back and says, 'Maybe you were right.' I think, with the amount of engagement we have with the Department of Defence, my normal expectation is that doesn't happen.
3.46Defence reiterated on a number of occasions that, although it did not negate the requirement to conduct a proper value for money assessment, the timeframe for the Hunter Class project was very compressed due to a decision of Government to ensure continual shipbuilding, and that there were significantly higher risks associated with that in terms of conducting the necessary assessments.
3.47Defence subsequently commented that ‘for any paperwork that is going before Investment Committee now, we are asking questions about the value-for-money determinations through the tender process and seeking line of sight from the earliest evaluation process…’.
3.48The audit report stated that Defence’s approach to the CPRs, lack of assessment or communication of value for money, and its lack of understanding of this in its response suggests:
… that further training and oversight may be required of Defence officials involved in high-level planning and advising on major capital acquisition projects, at all levels. There is also scope for more active engagement with the CPR policy owner.
3.49In its response to written questions from the Committee, Defence agreed that training would be beneficial to reinforce the requirements of the CPRs but advised that it had not planned or considered delivering this training.
Other advice to Government
3.50ANAO’s report also examined the advice from Defence to Government on the procurement of the Hunter Class Frigates and found that this advice was incomplete, particularly in relation to value for money as indicated in the previous section.
3.51There were two key decision points for Government in the initial stages of procurement of the Hunter Class Frigates, these were the first and second pass approvals. At the first pass government allocates funds to investigate options for the Hunter Class Frigates in further detail with the intent of narrowing the alternatives being examined. At the second pass government endorses a specific option and approves funding for its acquisition.
Advice provided at ‘first pass’
3.52The ANAO reported that Defence provided sufficient advice at the ‘first pass’ on ‘risk, cost and schedule to inform the Government’s decision to proceed to the competitive evaluation’. Defence’s first pass advice also noted that:
- the project was high risk, particularly the risks associated with schedule and design change
- the cost would be managed within Defence’s Integrated Investment Program
- all three reference ships designs had different design maturity, but would all require redesign work, and
- at the time of the advice there had not been direct industry engagement to support the quality of its costings.
Advice provided at ‘second pass’
3.53The audit reported that Defence’s advice to government at ‘second pass’ was not complete. To develop this advice, Defence used its assessment of the tenders against the government approved capability requirements. This advice was developed by Navy and internally reviewed by senior Defence Committees and the Secretaries’ Committee on National Security before being submitted to government.
3.54The ANAO also reported that Defence provided advice to government on the preferred capability, cost schedule and risk, but did not provide advice on value for money as discussed in the previous section.
3.55The ANAO reported that Defence rationale for the BAE 26 being recommended as the preferred option was primarily based on the anti-submarine warfare capability which aligned with the project’s objective and was one of the 23-capabiltiy requirements. Defence’s assessment against the 23-capability requirements did not and assess the maturity of the ship designs, however it did note that the Type 26 did not represent a ship in water at the time. The maturity of this design is discussed in more detail later in the chapter.
3.56The advice at second pass also did not include detailed whole-of-life cost estimates, and instead included only a ‘a rough order of magnitude whole-of-life cost estimate for BAE Systems’ tender’.
Unsubstantiated cost reduction in second pass advice
3.57The ANAO reported that the acquisition cost for the Hunter Class Frigates provided to government as part of the second pass approval included a 10 per cent cost reduction. This reduced the proposed cost by $2.1 billion. The audit report noted that Defence did not advise government that a cost reduction had not been negotiated with tenderers; or document the basis for this reduction.
3.58Advice from Defence’s Contestability Division in 2018 noted that there was an argument that project costs could reduce, however there was no evidence of this from Defence’s shipbuilding projects or the cost literature. In the 19May2023 public hearings Defence referred to this 10 per cent reduction as an ‘efficiency dividend’.
3.59In its response to questions on notice, Defence advised that the ten per cent reduction was applied to all three tenders included in the advice to government.
Defence responses
3.60Defence further advised in the May 2023 public hearing that reducing the cost in the advice provided to government without any agreement from the tenders ‘is not normal practice’ and stated that it could not explain why the department decided to reduce the cost. In response to questions on notice from the Committee, Defence stated that reducing the price provided by tenders ‘has not occurred in other tender evaluations’.
3.61Finance advice was included in the second pass approval, as is standard practice. This advice drew attention to the ten per cent price reduction, as well as noting the absence of whole of life cost estimates. However, Finance supported Defence’s recommendations to government.
3.62At the 20 November 2023 hearing, the Committee further queried the nature of the advice that was given to Government during different stages of the Hunter Class procurement, particularly at the second pass.
3.63As indicated in the previous section, Defence acknowledged that it should have given a value for money assessment in its cabinet submission. Defence further commented that:
We'd argue—and the ANAO found as well—that there were many parts of the process that were sound, but I believe the advice that went to government put an overemphasis on capability issues.
3.64Defence further noted that due to the project being brought forward by three years ‘the process of developing advice, tender evaluation, source evaluation and things like that was conducted within an accelerated time frame’. Defence further remarked:
I'd say the government was aware that bringing forward a program of this scale and complexity by three years obviously introduced additional areas of risk. It did ask us to look at how that would be managed, and I think we've done some of that. Prototyping has been an important part of risk mitigation.
3.65Defence also noted in its supplementary submission on the findings of its internal review that:
- after initial pass and up until first pass, there was no consistent expression of the goals and purpose of the procurement. Planning for the procurement fell into a process of disjointed advice to government that did not include deliberate steps to maintain clear coherent goals and a procurement method commensurate with the scale, scope and risk of the procurement
- the tender process was structured around achieving project objectives advised to tenderers but the advice to government was not complete with respect to the material outcomes of the process, affordability or compliance and risk assessments with respect to project objectives.
Record keeping
3.66The audit reported that Defence did not keep appropriate records of its procurement of the Hunter Class Frigates, and at times could not explain the rationale for key decisions, such as the 10 per cent reduction of the tender price discussed in the previous section.
3.67The ANAO found that Defence did not retain or could not locate complete records of the procurement, including key decisions. Defence did not have complete records of:
- the assessment and rationale for shortlisting all selected designs for the competitive evaluation process, including why it did not require a value for money assessment, comparative evaluation of the tenders, or ranking of tenders
- the discussion and decisions made by the senior level Defence Committee related to the Hunter Class Frigates
- delegate approval of the source evaluation report, which recorded the outcome of the evaluation process
- all identified probity matters, as required by its Process and Probity Plan.
- ANAO found that Defence’s approach to record keeping was not consistent with the CPRs which highlight that maintaining appropriate records is a fundamental element of accountability and transparency in procurement.
- In response to ANAO’s audit findings, Defence commented that it has over 730,000 documents within its records management system for this project. The Auditor-General noted the concerns of the ANAO at the 19 May 2023 public hearing that Defence was diminishing this finding, remarking that ‘our concern is not just that all records should be kept but that particularly important records should be kept’.
- The lack of documentation of key decisions and the rationale for these decisions was an issue ANAO identified multiple times in the audit report. Two key examples of this are:
- the lack of complete records of the Defence Capability and Investment Committee’s (DCIC) decision to shortlist frigate designs. Defence presented a paper to the DCIC on seven potential frigate designs, which assessed that four of the seven designs were viable, these were the Italian FREMM, the Modified F-100, BAE’s Type 26 and the French FREMM. The DCIC meeting records indicated that the Italian FREMM and Modified F-100 were considered the two most viable designs and that either the Type 26 or the French FREMM should be progressed as a third option. The meeting records stated that after discussion with the Secretary of Defence the Italian FREMM, Modified F-100 and BAE Type 26 be recommended to government for progression through the competitive evaluation process. However, the records do not state the rationale for the selection of the Type 26 over the French FREMM as the third option.
- the lack of records of the Defence Committee’s consideration of the draft second pass advice to government. The Defence Committee is the most senior enterprise-level committee in the department and on 15 March 2018 considered a presentation on the tender options for the Hunter Class Frigates and draft advice to government on this. Defence did not retain records a record of the discussions or outcomes of this meeting.
- At the 19 May 2023 public hearing, ANAO stated that the Defence Committee, as ‘an apex defence enterprise level committee, with well-established and elaborate secretariat arrangements which are designed to capture exactly this sort of decision-making’ did not have records to capture this decision making.
- Defence advised at this same hearing that the Defence Committee would normally have staff to take notes and prepare minutes and was not aware or another instance where critical minutes of key decisions have not been located.
- In its subsequent internal review findings provided to the inquiry, Defence acknowledged that its record keeping processes during this procurement were not compliant with CPR requirements:
- Mandatory record keeping obligations commensurate with the scale, scope and risk of the procurement were not complied with. This was inconsistent with the mandatory requirements of rule 7.2 of the Commonwealth Procurement Rules. The absence of documentation means that there is insufficient evidence to demonstrate how decisions were taken.
- The Auditor-General reiterated the position of the ANAO at the 20November2023 hearing on the importance of record keeping:
We based our audit on the records that were available through the entire period of the process. If there were conversations or engagements with ministers that weren't recorded, I'd find that quite unusual, or inappropriate, because they're official records which should be kept for the purposes of understanding the nature of the procurement process.
3.75Defence commented at this same hearing on the steps it had taken since the audit and its subsequent internal review to improve its record management processes:
… on the record-keeping issue we've pursued a number of initiatives to enhance our compliance with our records management policy and statutory record-keeping requirements. We established a new SES role—chief information governance officer—in April this year… The role of that officer is to integrate, promote, advise and improve the governance of Defence information records and data management. In August this year we also updated our records management policy.
Maturity of the frigate design
3.76The audit stated that when shortlisting potential designs for the Frigates, the RAND Corporation who undertook this was tasked with examining ‘only military-off-the-shelf options.’ From this examination, government then used essential criteria to shortlist designs.
3.77Military‑off‑the‑shelf does not have a clear definition but broadly refers to equipment that is not a new design and can be in-service with the armed forces of another country, is sourced from and established production facility and/or has minor modification to operate with existing or allied assets.
3.78Defence’s endorsement of the three shortlisted tenderer options (the Italian FREMM, Modified F-100 and BAE Type 26) also set out five project objectives to identify the outcomes sought by government. One of these objectives was to ‘deliver nine Anti‑Submarine Warfare Frigates (Ships) based on a Military-Off-The-Shelf design with a minimum level of change’.
3.79As reported in the audit, Defence advised the government that it had selected mature designs for consideration but did not include an assessment relating to this level of maturity. However, this advice to government did note that the BAE Type26 design did not represent a ship in water at the time, but that this was expected to occur in 2023.
3.80The ANAO identified findings in an internal Defence review from February 2022 that the BAE Type 26 was not a mature reference ship design and that it had matured far more slowly than anticipated. This finding was found by ANAO to have been reiterated in an internal report from January 2023:
The extent of the Type 26 design maturity was over-stated and therefore, the extent of cost and schedule risk was under-estimated. The Type 26 design is just now nearing completion and the first ship has just been launched, but not yet finished and tested.
3.81BAE Systems Australia (BAE) advised the Committee at the public hearing on 8September 2023 that it provided the government with an unprecedented level of transparency throughout the tender process, including on the maturity of the ship design:
The status of the reference ship was clear. It was in design and early build. It was maturing, and key elements of the program such as ship weight were still evolving as work continued.
3.82The audit indicated that the design ‘immaturity’ of the BAE Type 26 affected Defence’s planning, leading to an extension of the design and productionisation phase and diverting funds to pay for the extension and remediation activities. As a result, the project experienced an 18-month delay and additional costs. The head contract covering the design and productionisation work by BAE to support the build of the Hunter Class Frigates had also increased from $1,904.1 million when signed in December 2018, to $2,597.4 million as at 31 March 2023 (a 36 per cent increase).
3.83BAE advised the Committee that designing and building a complex ship is not a simple task at the best of times, and that COVID-19 had placed a further strain on this process, the impact of which could not be overstated:
The resident program team that [were] in the UK were brought home. The shipyard commissioning in Australia was delayed, and supply chain issues began to emerge. It was at this time we suffered some emergent issues on the reference ship that needed to be worked through. It was not just BAE Systems' elements of the program that were facing challenges through the pandemic. The radar system, combat management system and shipyard were all still evolving.
3.84BAE also noted that the main drivers for the ‘cost pressures’ facing the project were the scope changes and the inflation of supply chain costs. BAE stated that the material prices had increased at the highest rate in living memory due to the impact of COVID-19 and the war in Ukraine. In response to questions on notice from the Committee, BAE indicated that the head contract was designed so that the scope could be changed, which had occurred and been coordinated through the Commonwealth project team.
3.85BAE emphasised to the Committee in the September hearing that ‘Type 23 looks to set a mature benchmark of which Type 26 is a better ship in almost every way. So, the maturity and the heritage stretches back in anti-submarine warfare more than three decades’. BAE further stated:
The tender was clear. Our response was relatively clear. To the best of my knowledge, the company has done everything it can—and the British government—to provide complete transparency through that entire process… Idon't think anyone is trying to restrict information or hide information on levels of maturity. It's plain; it's there for everyone to see. People were in the shipyard through that entire process. No-one pretended that a Type 26 was in the water.
3.86The Committee further queried Defence at both the public hearings on 19 May and 20 November 2023 in relation to the maturity of the Hunter Class Frigate design. At the May hearing, Defence indicated that ‘the UK was five years' ahead of us in terms of where they were relatively in the program, so there would be a relative design maturity that was acceptable’.
3.87In response to a question taken on notice at the 20 November 2023 hearing on this issue, Defence stated that the positive assessment of design maturity was made by its own experts and by recognised international experts, further commenting:
One principle against which the designs were considered was whether the design was a mature design. Based on advice from the United Kingdom at the time, and the fact that the Type 26 was derived from the Type 23 vessel, the Type 26 design was assessed as meeting that criteria.
3.88The Secretary of Defence stated however at the public hearing on 20 November 2023 that he would ‘not have characterised it as a mature design’.
Capability of the Hunter Class frigates
3.89BAE advised at the September hearing that the Hunter Class Frigates will be a strong anti-submarine warfare capability:
At its core, Hunter [Class Frigate] is a stealth ship that has very low signatures that make it difficult for submarines to find and track. Hunter will survive in high‑tempo conflict in the Pacific where other ships may not due to the extensive focus on ship signatures, particularly in the underwater environment… it is also fitted with some of the most capable anti-air warfare systems currently available today. Hunter is formidable and, in our estimation, is currently without peer in the capabilities it will provide our Navy.
3.90BAE further stated in these discussions that it was developing a quality product in the Hunter Class Frigate and has received positive feedback that it is exceeding global benchmarks from the by the government Naval Shipbuilding Expert Advisory Panel.
3.91The audit indicated that the acquisition of the new frigates was a key component of Australia’s future naval and overall defence capability:
The acquisition of nine Hunter class frigates is a key part of the Australian Government’s substantial planned expenditure on naval shipbuilding and maritime capability and contributes to the ongoing capability of the Australian Defence Force.
3.92ANAO stressed in its audit report however that ‘Defence must manage both the Hunter class delivery schedule and the sustainment of its existing ANZAC class frigate capability, to maintain operational relevance and prevent a capability gap’.
3.93Defence noted in its observations following its internal review that:
The need for a frigate that delivers a high-end anti-submarine warfare capability modified to meet Australian requirements remains a key objective for the program. The Hunter class frigate has been designed to meet this key requirement.
3.94In a subsequent response to a question on notice regarding naval classification standards, Defence commented that the Australian Naval Classification (ANC) Framework had recently been developed and then launched in 2023 to determine the contemporary rule set for the design and construction of Australian Defence vessels. Defence stated:
It [ANC] updates and refines international and Australian standards and legislation into a single set of Australian Defence vessel design rules. This will support innovation and provide a blueprint for the classification of Australia’s Defence vessels. The rules will apply to all future Defence maritime capabilities purchased off the shelf or designed and constructed in Australia and overseas. Industry will continue to play a key role in assuring the seaworthiness of Defence vessels under the ANC Framework.
Australian industry capability
3.95The initial shortlisting criteria in 2015 required that the reference ships be buildable and supportable in Australia. Two of the five project objectives in the endorsement to proceed with the request for tender in 2017 were to ‘contribute to a Continuous Naval Shipbuilding industry in Australia’ and ‘maximise Australian Industry Capability’. Additionally one of the criteria used to assess the three tender options was if the tender ‘Maximises Australian Industry Capability during the term of the Head Contract and facilitates utilisation of Australian Industry Capability during sustainment.’
3.96The audit also noted however that the ‘contribute to a Continuous Naval Shipbuilding industry in Australia’ project objective was one of three assessed as high risk by Defence.
3.97Defence advised the Committee that BAE has contracted targets for 54 per cent of spending to be on Australian Industry Content (AIC) in the current planning and productionisation phase, with a target of 58 per cent of the overall contract. BAE later advised that its AIC involvement was calculated using the value of work undertaken in Australia.
3.98Defence further advised that BAE was exceeding its current targets, which BAE clarified at a later public hearing to be approximately 10 per cent above the target for AIC content for the current phase of the project. Defence stated on notice that ‘the transfer of skills will be monitored to ensure the required design and construction skills are in place in accordance with the Sovereign Capability and Option Deed.’
3.99At the public hearing on 8 September 2023, BAE outlined the industry capability development that has occurred to date at the Osborne naval shipyard in South Australia arising in more detail:
- the combat system is maturing, the radar has matured, and elements of the shipyard that were behind schedule, such as the pipe shop, are now online
- cut steel [is] on the blocks that will go into the first ship in May [2024], some 13 months ahead of the new agreed schedule
- [the] workforce now number[s] 1,758 people
- the engineering team now stands at 572 staff across all disciplines
- more than 170 engineering toolsets have been transferred. A digital shipyard has been developed and commissioned
- 56 apprentices on the program… rising to 150 apprenticeships [in] 2025. Academic partnerships… with the University of South Australia, Flinders, Melbourne and RMIT.
Committee comment
3.100The procurement of the Hunter Class Frigates clearly fell short of requirements in key respects. The failings were clearly identified in the Auditor-General’s report yet only belatedly accepted by Defence during this inquiry after its own internal review. It is genuinely perplexing to the Committee why Defence was so defensive (no pun intended) and kept rejecting, denying or dismissing obvious failings in the process during and after the audit report was tabled. The Committee appreciates the Secretary having appeared personally during the inquiry to address the issues raised in the report and the additional evidence then provided.
3.101The Committee understands and accepts the significant pressure and risk imposed on Defence as a result of the then Government’s decision to suddenly accelerate the project, reducing the available time by around three years. There will be a multitude of complexities that arise in the building of new sophisticated modern naval vessels as it is a huge undertaking. It is accepted also that there were significant supply chain issues for everybody during the height of the COVID-19 pandemic and appreciably heightened costs and delays that were beyond the control of BAE and Defence.
3.102However, the core principles outlined in the CPRs of demonstrating value for money are fundamental to any expenditure by government on behalf of the taxpayer and it is patently evident that they were not adhered to in this process. Pressure or urgency does not suspend the requirement to observe or ability to comply with the CPRs, and especially so in relation to such an enormous amount of taxpayer money.
3.103The fact that no value for money assessment was conducted by Defence on a (then) $35 billion procurement and that “government” in some undefined process was somehow expected to do this for themselves is baffling to say the least. No explanation was given as to why the requirement for value for money was mysteriously removed from the Tender Evaluation Plan.
3.104Some intimations were made during the inquiry that the requirement to construct the ships in Australia somehow justified the process. The Committee firmly rejects any such suggestion or conclusion. It is entirely reasonable that a government express a policy requirement for domestic manufacturing of this sort of capability, presumably to strengthen Australia’s defence industrial base. Specifying such a policy requirement however does not mean a government can then choose a favourite/preferred shipbuilder without a value for money assessment. There was no evidence whatsoever that BAE was the only tenderer willing and able to construct ships in Australia.
3.105It is acknowledged that Defence now accepts the lack of a value for money assessment as a deficiency in the process, having conducted an internal review, but it should have done so when formally responding to the audit; instead, Defence chose to argue that value for money assessments had been done. This required ANAO to essentially issue its own version of a scathing rebuttal in the report in the form of detailed further comments highlighting that this was clearly untrue.
3.106It is striking that neither Defence nor the ANAO were able to identify any other project that went to Government for decision without a value for money assessment. Ministers have every right to be able to rely on the detailed and technical assessments which underpin such processes and advice to government, whether to Ministers individually or collectively via Cabinet. The evidence however clearly indicates that this submission which went to Ministers was unique for not including a value for money assessment. Despite this, the former Government decided to select BAE for a (then) $35 billion project anyway in breach of Finance Law.
3.107Ministers are not supposed to be rubber stamps or daleks and there are two possibilities as to how this happened: (1) either no one noticed that no value for money assessment was undertaken; or (2) they did know but didn’t care and blithely decided to proceed with a (then) $35 billion procurement anyway. Ultimately as this was a Cabinet process via the National Security Committee of Cabinet no one will ever really know what happened; whether there was a conspiracy or predetermined decision that BAE win the prize, or whether it was simply shocking incompetence by this group of Ministers in the then Government.
3.108The required role of Finance through this process is also puzzling, particularly given the scale of military acquisitions of this nature. It is strange to the Committee that the rules required Finance to have appropriately prepared a Cost and Risk statement to advise Government following the selection of BAE as the preferred tenderer but did not require it to play any further role in assessing whether value for money was actually being demonstrated.
3.109Finance has indicated that it would probably take a different approach for future procurements of this nature and scale. The CPRs should be amended to explicitly require Finance to determine whether an appropriate value for money assessment has been completed for large-scale acquisitions by the procuring agency, and then provide the appropriate advice to that entity if this is not the case.
3.110Specific mention must be made of the perplexing decision to knock off 10 per cent of the price from all tenderers in the evaluation and advice to government. No rationale was provided or identified for this seemingly unprecedented action. While the Committee would love to think the Commonwealth could just buy everything for 10 per cent less than a tendered price, it’s a patently ridiculous proposition and vague claims there might be an “efficiency dividend” raise reasonable questions about the competence of the officials involved. Indeed, it is not apparent to any member of the Committee whether there has ever been an Australian shipbuilding project for such a major new capability that has run under budget. Given Finance’s evidence, the Committee would expect such a buyer-desired discount would not be dreamt up again.
3.111The acquisition of modern naval vessels is crucial for Australia as an island nation to maintain an effective maritime defence capability, including possible threats from submarines. The issue of design maturity for the Hunter Class frigates was therefore a critical consideration but this ship is not in the water anywhere in the world and is seemingly still at the pre-prototype stage.
3.112The Committee understands that it is based on a successful ship that has been in service for many years, but this is a completely redesigned and updated vessel that is yet to actually exist. The assessment by Defence through its panel of in-house and international experts that the Hunter Class frigate design was ‘mature’ simply makes no sense–they were sold a picture of a ship that might exist in the future but evidently was NOT a mature design. The Secretary of Defence admitted this by making the welcome, if somewhat overdue, statement at the 20 November 2023 hearing that he would not have characterised it as mature.
3.113This issue of maturity of course relates to the capability of the vessel and its overall cost effectiveness both at the time of procurement but also at construction, as a result of numerous changes to capability requirements and design along the way –which has served to add significant time, cost and risk. Defence’s ability to fully assess the capability Australia is buying during the procurement process was seriously reduced as a result of the actual immaturity of the design it was sold. In many key respects the ship that will ultimately be built is significantly different to what was advertised as required or has taken months or years longer to (re-)design to be able to meet specifications.
3.114Defence must reassess how it determines maturity in future large-scale acquisitions, particularly when dealing with foreign governments who will always be keen to sell expensive military hardware to Australia. The Committee invited the Government of the United Kingdom or its representatives to appear however they declined to do so, so there was no opportunity to explore the UK Government’s role. In any event, the Australian Government has the right to expect an extensive level of due diligence by Defence in these circumstances, including a thorough testing of any claims made by a prospective tenderer or the government of their home country.
3.115The Committee understands also that an evolution of design can often be justified in relation to procuring military assets that are still at the concept phase but can potentially deliver key capabilities to Australia. The Committee is mindful going forward however of the balance needed between this approach and purchasing an ‘off-the-shelf’ military capability which would be expected to be deliverable far more quickly and at considerably less expense.
3.116This is an issue that has been scrutinised previously. The Defence Procurement Review ledby Malcolm Kinnaird AO more than 20 years ago (Kinnaird Review) found that ‘continuing delays in the delivery of major defence equipment mean that the ADF has failed to receive the capabilities it expects, according to the schedule required by the Government’. This report further commented that:
Judgements need to be made concerning what mix of capability and what trade offs between new and existing equipment are in the nation’s interests.
3.117The Kinnaird Review further recommended that:
… an off-the-shelf solution must be part of any set of options put to government to ensure that a benchmark is established against which the costs, military effects and schedule of all proposals can be assessed.
3.118A later report in 2008 on Defence procurement and sustainment, led by David Mortimer AO, that examined the progress in implementing the reforms from the Kinnaird review, made the follow-up recommendation that:
Any decisions to move beyond the requirements of an off-the-shelf solution must be based on a rigorous cost-benefit analysis of the additional capability sought against the cost and risk of doing so. This analysis must be clearly communicated to Government so that it is informed for decision-making purposes.
3.119The Committee takes the view that Government should be required to consider off-the-shelf alongside developmental options for military procurements and make sensible choices in this regard, particularly with regard to risk. The Committee intends to explore this further in its future MPR inquiries.
3.120With regard to the continuing work to finalise the design of the Hunter Class Frigates and actually build the ships, the Committee is mindful of the ongoing and necessary tension between the role of capability managers and delivery managers after a procurement decision is made. Capability managers and the services have significant ongoing say in changes to scope and design which may be warranted but which can significantly delay or increase risk in a project. If capability is to be delivered to the war fighter as quickly as possible then the practical realities of delivery, industry capacity and trade-offs need significant weight in finalising designs and future changes. The Committee will also give this issue further consideration in future MPR inquiries.
3.121Recordkeeping was a constant area of prosecution by the Committee in its extensive Commonwealth procurement inquiry in 2023 and disappointingly, but, perhaps not surprisingly, was an issue also in this procurement process. The lack of recordkeeping highlighted in the Auditor-General’s report was acknowledged by Defence, which agreed to the corresponding recommendation. Defence’s formal response to this issue in the audit report was, however, dismissive if not flippant.
3.122The Committee fully supports the ANAO’s position that the unavailability of only a very miniscule proportion of the relevant documentation is simply not the point it was trying to make. The fact of the matter is that records of how some key decisions were made were missing, and this is never going to be acceptable. In particular it is astounding that key documents which go to the core concerns about the process went missing, including minutes of the Defence Committee–the apex decision making forum of the entire enterprise. Defence has at least now admitted this failing after its internal review, and the advice that it is adopting a new framework for records management is reassuring.
3.123The development of Australia’s shipbuilding industry into the future is hugely important and it is to be hoped that the construction of the Hunter Class Frigates will go a long way to fostering this. The Committee accepts that this project was high-risk given the new and very constrained timeframe that Defence was presented with by the Government at that time. Defence has accepted where it went wrong, which is now also acknowledged, but it would have been better to have done so straight away and come clean when the Auditor-General Report was handed down. It is to be hoped that this will be its approach in its response to future audits.
3.124The Committee makes the following recommendations.
3.125The Committee recommends that the Department of Defence provides it with an update at both 6 and 12 months on the progress of the changes arising from its internal review findings.
3.126The Committee recommends that the Department of Defence provides it with an update in 12 months on the progress of the Hunter Class Frigate project, including the industry capability uplift and a value for money assessment.
3.127The Committee recommends that the Department of Defence report back in six months from the tabling of this report as to how it will assess design maturity in future procurements.
3.128The Committee recommends that the Department of Defence provides it with an update in six months on the implementation of its new recordkeeping framework and the impact of the new Chief Information Governance Officer role.
3.129The Committee recommends that Commonwealth Procurement Rules be amended to explicitly require:
- that a value for money assessment must be included in a tender evaluation plan unless the accountable authority approves an exemption from this requirement, and
- that the Department of Finance must determine and then advise the procuring entity whether these value for money assessments have been completed appropriately.
Mr Julian Hill MP
Chair
19 June 2024