Department of Defense’s Procurement of Hunter Class Frigates

Introduction

1.1 The Royal Australian Navy (the Navy) currently has eight ANZAC class frigates. The ANZAC class is a long-range frigate capable of air defence, surface and undersea warfare, surveillance, reconnaissance and interdiction. The first of class ship, HMAS ANZAC, was commissioned in 1996. The 2009 Defence White Paper announced that:

The Government will also acquire a fleet of eight new Future Frigates, which will be larger than the Anzac class vessels. The Future Frigate will be designed and equipped with a strong emphasis on submarine detection and response operations. They will be equipped with an integrated sonar suite that includes a long-range active towed-array sonar, and be able to embark a combination of naval combat helicopters and maritime Unmanned Aerial Vehicles (UAV).⁸

1.2 The 2016 Defence White Paper stated that:

The Government is bringing forward the future frigate program to replace the Anzac Class frigates. A continuous build of the Navy’s future frigates will commence in 2020. The future frigates will be built in South Australia following completion of a Competitive Evaluation Process.⁹

1.3 On 29 June 2018, the Australian Government announced the outcome of the competitive evaluation process:

The frigates, to be designed by BAE Systems and built by ASC Shipbuilding, are central to our plan to secure our nation, our naval shipbuilding sovereignty and create Australian jobs.

BAE’s Global Combat Ship – Australia will provide our nation with one of the most advanced anti-submarine warships in the world – a maritime combat capability that will underpin our security for decades to come.

The Future Frigates, named the Hunter class, will be built in Australia, by Australians, using Australian steel.

This $35 billion program will create 4,000 Australian jobs right around the country and create unprecedented local and global opportunities for businesses large and small.

The Hunter class will begin entering service in the late 2020s replacing the eight Anzac Frigates, which have been in service since 1996.¹⁰

1.4 Construction of the Hunter class frigates is part of the Australian Government’s continuous naval shipbuilding program intended to develop sovereign Australian shipbuilding and sustainment. The Australian Government’s 2020 Force Structure Plan publicly reported that the cost of the Hunter class frigates was $45.6 billion out-turned.¹¹

SEA 5000 Phase 1 – Hunter class frigates design and construction

1.5 Nine Hunter class frigates, based on BAE Systems’ Type 26 Global Combat Ship design with Australian modifications, are to be acquired under Phase 1 of the Hunter class frigate program (SEA 5000).¹² Project SEA 5000 Phase 1 (the project) is focused on design, construction and delivery of the Hunter class mission and support systems. An image of the planned Hunter class frigate is at Figure 1.1.

Figure 1.1: Image of the planned Hunter class frigate

Source: Image of the planned Hunter class frigate provided by Defence.

1.6 The project is to be delivered in the following five stages:

• competitive evaluation process to identify a designer and builder — completed in 2018 (discussed in chapter two of this audit report);
• design and productionisation — in progress (discussed in chapter three of this audit report);
• batch one build (ships 1–3) (planned to be considered and contracted to follow the design and productionisation stage);
• batch two build (ships 4–6) (planned to be considered and contracted to follow the construction of batch one); and
• batch three build (ships 7–9) (planned to be considered and contracted to follow the construction of batch two).¹³

1.7 The platform characteristics and primary systems of the approved Hunter class design are summarised in Figure 1.2. Key modifications to BAE System’s Type 26 Global Combat Ship (known as the reference ship design), to meet Australian requirements, include the integration of the United States Navy’s Aegis combat management system (CMS) with a Saab Australian interface and Australian CEA Technologies phased array radar.¹⁴

Figure 1.2: Platform characteristics and primary systems of the Hunter class frigates

Source: Defence.

Project management arrangements

1.8 The Chief of Navy is the capability manager, and the Navy is the capability owner.¹⁵ Within the Navy, the Director-General Surface Combatants and Aviation (the Program Sponsor) is responsible for ensuring that the outcomes of all program activities are achieved and that these outcomes remain aligned with Defence strategic objectives. Within the Surface Combatants and Aviation Branch, the Director Frigates (the Capability Project Sponsor) sets direction for the project and ensures that activities and outputs are consistent with the capability needs and priorities of the capability user.

1.9 Defence’s Naval Shipbuilding and Sustainment Group is responsible for managing the SEA 5000 Phase 1 acquisition on behalf of the Navy.¹⁶ Within the Naval Shipbuilding and Sustainment Group, the Director-General Hunter Class Frigates (the overall Program Manager) is accountable for delivery of the mission and support systems. The Director-General Hunter Class Frigates is supported by the Director-General Maritime Integrated Warfare Systems, who is responsible for the combat system. The Hunter class project is managed by the Hunter Class Frigates Branch which is part of the Major Surface Combatants and Combat Systems Division. The project is managed day-to-day by the project team and Project Director based in Canberra with onsite project management provided by the Naval Construction Branch based at the Osborne shipyard in South Australia.

Head contract

1.10 On 14 December 2018, Defence entered into a head contract with ASC Shipbuilding (a subsidiary of BAE Systems Australia) valued at $1,904.1 million, covering the design and productionisation work to support the build of the Hunter class frigates As discussed in paragraphs 1.13 to 1.15, ASC Shipbuilding commenced trading as BAE Systems Maritime Australia (BAESMA) on 11 December 2020.

1.11 As at 31 March 2023, the value of the head contract had increased to $2,597.4 million. The key components of the head contract price as at 31 March 2023 are outlined in Table 1.1.

Table 1.1: Components of the head contract price at 31 March 2023 ($AUD equivalent)

Note a: The management services and design and productionisation component prices include amounts for management reserve, uncertainty and other adjustments, as well as scope fee comprising BAE Systems Maritime Australia’s profit margin (see paragraphs 3.21 to 3.23).

Note b: Long lead time items are defined under the head contract as: ‘a Mission System component or Support System Component that: a) the Contractor commits to procure as part of a Scope which will be delivered to the Commonwealth as part of another Scope; and b) is necessary to ensure timely delivery of the Supplies in accordance with the Approved CMS [Contract Master Schedule]’.

Note c: The ‘pass through’ component of the contract price comprises funding for expenses incurred by BAE Systems Maritime Australia in performing the work under the contract on a cost recovery basis for which no fee is to apply, in accordance with allowable cost rules. Examples include securities; warranties; intellectual property licence fees and royalties; insurances; travel and relocation costs; government fees and charges; and shipyard and Commonwealth premises costs including lease or licence fees, and utilities.

Note: Column and row totals may not add up due to rounding of individual figures.

Source: Defence documentation.

1.12 The head contract established between the Commonwealth and BAESMA sets out terms to govern the long-term relationship and contains specific provisions for management services and the design and productionisation scope of the project. Defence plans to return to the Australian Government for approval for subsequent scopes to be added under the head contract, starting with the batch one build (ships 1–3).

ASC Shipbuilding (later BAESMA)

1.13 As part of the procurement process and prior to execution of the head contract, the Commonwealth transferred ASC Shipbuilding to BAE Systems Australia at a nominal cost of $1.00 on 14 December 2018. The Commonwealth subsequently entered into the head contract for the Hunter class frigate program with ASC Shipbuilding. On 29 June 2018, the same day as the outcome of the competitive evaluation process was announced, the Australian Government announced the transfer of ASC Shipbuilding:

ASC Shipbuilding, currently wholly owned by the Commonwealth, will become a subsidiary of BAE Systems during the build. This ensures BAE Systems is fully responsible and accountable for the delivery of the frigates and ensures the work will be carried out by Australian workers and create Australian jobs.

The Commonwealth of Australia will retain a sovereign share in ASC Shipbuilding while BAE manages the program. At the end of the program the Commonwealth will resume complete ownership of ASC Shipbuilding, thereby ensuring the retention in Australia of intellectual property, a highly skilled workforce and the associated equipment.

By the conclusion of the frigate build, ASC Shipbuilding will be a strategic national asset capable of independently designing, developing and leading the construction of complex, large naval warships.¹⁷

1.14 The transaction formed part of a broader restructure of ASC Pty Ltd, a Government Business Enterprise¹⁸, under which ASC Shipbuilding, including workforce engaged on the Air Warfare Destroyer and Offshore Patrol Vessel projects, were transferred to BAE Systems Australia.

1.15 ASC Shipbuilding commenced trading as BAE Systems Maritime Australia (BAESMA) on 11 December 2020.

Strategic relationship

1.16 The head contract between the Commonwealth and BAESMA commits the two parties to work to develop a strategic relationship in accordance with a set of principles (the principles and corresponding performance measures are discussed at paragraphs 3.18 to 3.20 of this audit report).¹⁹ The parties have agreed to ‘work together in a cooperative and collaborative manner to achieve the contract objectives’, including by ‘developing a culture of open communication and transparency’ and ‘discussing all issues in an open and honest manner’. As discussed at paragraph 3.40, Defence established a Team Hunter Enterprise Plan to give effect to these principles, comprising of 24 initiatives to be implemented by the end of 2022.

Project funding and expenditure

1.17 Actual project expenditure at 31 January 2023 was $2,225.9 million, with $1,308.4 million spent on the head contract with BAESMA. The allocated funding and actual expenditure as at 31 January 2023 on the Hunter class program and associated project costs are outlined in Table 1.2.

Table 1.2: Allocated funding and actual expenditure at 31 January 2023 ($AUD)

Note: Column and row totals may not add up due to rounding of individual figures.

Source: ANAO analysis of Defence documentation.

Previous Auditor-General reports

1.18 Since 2016–17, the Auditor-General has tabled seven performance audit reports relating to naval procurement, maritime sustainment and related matters.

• Auditor-General Report No. 48 2016–17 Future Submarine — Competitive Evaluation Process.
• Auditor-General Report No. 39 2017–18 Naval Construction Programs — Mobilisation.
• Auditor-General Report No. 30 2018–19 Anzac Class Frigates — Sustainment.
• Auditor-General Report No. 22 2019–20 Future Submarine — Transition to Design.²⁰
• Auditor-General Report No. 12 2020–21 Defence’s Procurement of Offshore Patrol Vessels — SEA 1180 Phase 1.
• Auditor-General Report No. 15 2021–22 Department of Defence’s Procurement of Six Evolved Cape Class Patrol Boats.
• Auditor-General Report No. 7 2022–23 Defence’s Administration of the Integrated Investment Program.²¹

1.19 The Auditor-General has made recommendations to Defence on retaining evidence and advice regarding decision-making in procurement. Key messages from these reports included maintaining adequate records when undertaking complex negotiations and having effective oversight to realise value for money under a contract.

1.20 Project SEA 5000 Phase 1 (Hunter class frigates) has also been included in the annual Defence Major Projects Report (MPR) since 2019–20.

• Auditor-General Report No. 19 2020–21 2019–20 Major Projects Report, pp. 151–58.
• Auditor-General Report No. 13 2021–22 2020–21 Major Projects Report, p. 115 and pp. 135–42.
• Auditor-General Report No. 12 2022–23 2021–22 Major Projects Report, p. 116 and pp. 137–45. This is the most recent MPR, presented to the Parliament on 9 February 2023.

Rationale for undertaking the audit

1.21 The acquisition of nine Hunter class frigates is a key part of the Australian Government’s substantial planned expenditure on naval shipbuilding and maritime capability²² and contributes to the ongoing capability of the Australian Defence Force.²³ This audit examined the effectiveness of the Department of Defence’s (Defence) procurement of Hunter class frigates to date and the achievement of value for money through Defence’s procurement activities.

1.22 The audit builds on previous Auditor-General work on Defence’s acquisition and sustainment of Navy ships and implementation of the Australian Government’s 2017 Naval Shipbuilding Plan, to provide independent assurance to the Parliament on Defence’s planning, procurement, decision-making and advising, contracting and delivery of the Hunter class frigates to date.

Audit approach

Audit objective, criteria and scope

1.23 The objective of the audit was to assess the effectiveness of the Department of Defence’s procurement of Hunter class frigates and the achievement of value for money to date.

1.24 To form a conclusion against the objective, the following high-level criteria were adopted.

• Did Defence conduct an effective tender process?
• Did Defence effectively advise government?
• Did Defence establish fit-for-purpose contracting arrangements?
• Has Defence established effective contract monitoring and reporting arrangements?
• Has Defence’s expenditure to date been effective in delivering on project milestones?

1.25 The audit focused on Defence’s procurement process for the design and productionisation of the Hunter class frigates (SEA 5000 Phase 1) including the rationale for shortlisting decision-making, the tender assessment process, the evidence base for advice to the Australian Government and the execution of contract-based project management and reporting mechanisms. At the time of the audit, the head contract had been signed. Contracts for the building of frigates had not been established.

1.26 The audit did not examine related procurements associated with SEA 5000 Phase 1 including the selection of the combat management system²⁴, the acquisition of government furnished equipment²⁵, the development of naval shipbuilding infrastructure and facilities, or the ASC restructure.

1.27 This audit reports on Defence procurement activity and developments in project SEA 5000 Phase 1 (Hunter class frigate design and construction) to March 2023. The government and Defence have indicated that the planned Hunter class capability has been considered as part of the Defence Strategic Review and related government processes.²⁶ Defence advised the ANAO in April 2023 that:

As at 20 March 2023 there have been no material changes to the Hunter Class Frigate project as a result of the Defence Strategic Review, or other Defence or Government decisions.

Audit methodology

1.28 The audit procedures included:

• reviewing Defence records, including procurement planning, tender assessments, advice, and contract management documentation;
• discussions with Defence officials and Defence contractors;
• walkthroughs of Defence systems; and
• discussions with Department of Finance officials.

1.29 The audit was open to contributions from the public. The ANAO received and considered two submissions.

1.30 The ANAO conducted fieldwork at Defence offices in Canberra, the Osborne shipyard in South Australia, the Henderson shipyard in Western Australia and Fleet Base West in Western Australia.

1.31 The audit was conducted in accordance with ANAO Auditing Standards at a cost to the ANAO of approximately $854,701.

1.32 The team members for this audit were Mark Rodrigues, James Woodward, David Willis, Helen Sellers, Emily Hill, Jude Lynch, Corne Labuschagne, Danielle Page, Sally Ramsey and Amy Willmott.

2.1 When undertaking procurement activities, an entity’s accountable authority has a duty to promote the proper (efficient, effective, economical and ethical) use and management of public resources in accordance with the Public Governance, Performance and Accountability Act 2013 (PGPA Act) and to comply with the Commonwealth Procurement Rules (CPRs).²⁷ An effective procurement and decision-making process is demonstrated by:

• a value for money focus;
• following approved processes, including those in the approved procurement plan;
• maintaining appropriate records, which underpin the accountability and transparency of procurement and decision-making processes; and
• providing decision-makers with advice that is clear, accurate, complete and timely.

Did Defence conduct an effective tender process?

2.2 On 4 August 2015, the Prime Minister and the Minister for Defence announced that the Australian Government was:

Bringing forward the Future Frigate programme (SEA 5000) to replace the ANZAC class frigates. As part of this decision, we will confirm a continuous onshore build programme to commence in 2020 – three years earlier than scheduled under Labor’s Defence Capability Plan. This decision will save over 500 hundred jobs and help reduce the risks associated with a ‘cold start’. The Future Frigates will be built in South Australia based on a Competitive Evaluation Process, which will begin in October 2015.²⁸

Assessment and shortlisting process

2.3 The Department of Defence (Defence) conducted an iterative process to assess and shortlist ship designs whose designers would be invited to participate in the competitive evaluation process.²⁹ The shortlisting process that followed the government’s August 2015 announcement involved the following steps.

• An initial market survey and analysis by the RAND Corporation (RAND)³⁰ to identify potentially relevant ship designs. RAND was tasked with examining only military-off-the-shelf design options, with the contracted statement of work excluding new, or clean sheet, designs.
• Consideration of the identified designs by the Defence Ship Building Steering Group³¹ (chaired by the Chief of Navy) in September 2015.
• Agreement by the government in November 2015 (‘interim pass’) to progress analysis of the initial group of designs that had been identified.³²

2.4 In November 2015, the government agreed to the ‘essential criteria’ to be used to further shortlist down to the final three preferred designs. The essential criteria were that the ships³³:

• be buildable in Australia within program budget and starting in 2020;
• meet Navy’s capability requirements;
• be able to accommodate communications and combat management systems compatible with Navy’s surface fleet, and comply with applicable Australian legislative and regulatory requirements;
• be based on a steel hull; and
• be supportable in Australia for operation and sustainment.

2.5 Following further shortlisting assessments by RAND³⁴ and Defence, the project sponsor (the Chief of Navy) presented a paper on the future frigate design options to the February 2016 meeting of the Defence Capability and Investment Committee.³⁵ The paper advised that Defence’s assessment was that four of the seven assessed designs were viable — the Italian FREMM, the Modified F-100, BAE’s Type 26 and the French FREMM — as the designs were:

most likely to:

• Be compliant with the RAND shipbuilding Principles;
• Meet a 2020 construction start date inclusive of modifications; and
• Sufficiently meeting [sic] the capability requirements.

2.6 The Defence Capability and Investment Committee meeting records state that ‘after discussion, the Secretary [of Defence] agreed that the Italian FREMM (Fincantieri), Modified F-100 (Navantia) and Type 26 (BAE) be recommended to the government for progression through the SEA 5000 Phase 1 Competitive Evaluation Process.’ The meeting records indicated that the Italian FREMM (Fincantieri) and Modified F-100 (Navantia) were considered the two most viable designs and that either the Type 26 or the French FREMM should be progressed as a third option.

Record keeping

2.7 Defence did not retain complete records of the key decisions made during the shortlisting process for the competitive evaluation activity. Records not retained by Defence included the following.

• The basis for the Ship Building Steering Group’s decision to approve seven ship designs for further analysis. It was not clear whether Defence had accepted RAND’s initial shortlist or made the decision to progress analysis on seven ship designs on another basis.³⁶
• The rationale for the Defence Secretary’s (the decision-maker’s) selection of the BAE Type 26 over the French FREMM (DCNS) as the third option.³⁷

2.8 The approach adopted by Defence to its record keeping is not consistent with the July 2014 Commonwealth Procurement Rules (CPR) requirements, which applied at that time. Successive iterations of the CPRs have highlighted that maintaining records is one of the ‘fundamental elements of accountability and transparency’ in procurement.³⁸ The requirements for record-keeping are long-standing and appear in section 7 of the CPRs. They state that:

• Officials must maintain for each procurement a level of documentation commensurate with the scale, scope and risk of the procurement.
• Documentation should provide accurate and concise information on: the requirement for the procurement; the process that was followed; how value for money was considered and achieved; relevant approvals; and relevant decisions and the basis of those decisions.
• Documentation must be retained in accordance with the Archives Act 1983.³⁹

2.9 Further, the Defence Records Management Policy notes that:

Defence must manage its records in a way that:

a. complies with legislation, standards and government policy;

b. provides for public accountability;

c. supports decision-making; and

d. preserves corporate memory and historical information.

To meet this requirement, all Defence records are:

a. created to support business and meet obligations;

b. captured in digital format and described;

c. made accessible and disclosed where required; and

d. appraised, retained and disposed of in accordance with the principles in this policy.

2.10 In addition to the risk of non-compliance with the CPRs, incomplete record keeping makes it difficult for Defence to: demonstrate that the procurement was conducted with due regard to fairness, probity and value for money; and facilitate scrutiny and review of its procurement processes and decisions, including by the Parliament.⁴⁰

2.11 Further shortcomings in Defence record-keeping are discussed in paragraphs 2.34 to 2.35, 2.44, 2.63, 2.66 to 2.67, 2.73 and 2.78 of this audit report. These deficiencies raise issues of transparency, accountability and non-compliance with the CPRs and Defence Records Management Policy. Defence’s record keeping has also been identified as an issue in prior ANAO performance audits.⁴¹

2.12 The Hunter class procurement is a long-term activity. Given the weaknesses in record keeping identified in this audit, Defence should implement measures to ensure compliance with its Records Management Policy over the life of the program.⁴²

2.16 In April 2016, the government agreed (‘first pass’ approval) to: the commencement of the competitive evaluation process for the selection of the head contractor; Defence’s three shortlisted ship designs; and 23 high-level capability requirements.⁴³ The competitive evaluation process was to comprise:

• a risk reduction design study; and
• a Request for Tender (RFT) process.

2.17 Defence advised the government that a suitable design and an affordable and viable build strategy would be presented at the ‘second pass’ government approval stage. In its recommendation to progress the competitive evaluation process, Defence noted that following this process the government would be in a position to choose a preferred option based on the ability to start construction in 2020, the capability requirements, minimal design change and value for money. Government agreed to funding of $289.3 million for the competitive evaluation process.⁴⁴

2.18 Following the government’s agreement to the procurement approach, Defence did not update the existing October 2014 Acquisition and Support Implementation Strategy (procurement plan)⁴⁵ or develop a new procurement plan to reflect the change from the approach envisaged in October 2014 and associated risks.⁴⁶ The development of a formal acquisition strategy or procurement plan was a mandatory requirement of the Defence Procurement Policy Manual in effect at that time. Further, in 2016 first pass advice to government the adoption of a suitable Acquisition and Support Implementation Strategy had been identified by Defence as a mitigation for the risks to implementation (which were assessed as ‘extreme’).

Risk reduction design study

2.19 In August 2016 Defence commenced risk reduction design studies with each of the three tenderers. The studies were conducted to inform Defence’s understanding of the consequences of applying the ‘Australianised’ changes on the reference ship designs and to try to reduce the cost and schedule risk associated with the changes.

2.20 Defence intended to use the information to form the basis of the technical requirements for the RFT. Defence received the risk reduction design study deliverables from the tenderers in May 2017 following release of the RFT. The deliverables were assessed as part of the tender evaluation in November 2017.

Request for Tender for the head contract

2.21 On 28 March 2017 an Endorsement to Proceed (the EtP) with the RFT was approved by the Director-General Future Frigates (civilian Senior Executive Service Band 1 official). According to the EtP, the RFT was:

to establish a long term relationship with a Tenderer so as to assist the Commonwealth to achieve the Project Objectives in the most efficient, effective and innovative manner.

2.22 The RFT document was released on 31 March 2017 to the three tenderers. The conditions of tender provided to the tenderers stated that ‘Tenders will be evaluated utilising the tender evaluation criteria at clause 3.9 to determine the tender that will best support the achievement of the Project Objectives on a value for money basis’. The Minister for Defence Industry announced the release of the RFT, stating that:

The release of the RFT is an important part of the Competitive Evaluation Process which will lead to the Government announcing the successful designer for the Future Frigates in 2018.

…

Three designers—BAE Systems with the Type 26 Frigate, Fincantieri with the FREMM Frigate, and Navantia with a redesigned F100, have been working with Defence since August 2015 to refine their designs.

The three shortlisted designers must demonstrate and develop an Australian supply chain to support Australia’s future shipbuilding industry, and also how they will leverage their local suppliers into global supply chains.

The Government is committed to maximising Australian industry opportunities and participation and this project will contribute to building a sustainable Australian shipbuilding workforce.⁴⁷

2.23 Responses to the RFT were due on 24 July 2017. On 29 June 2017, Defence wrote to tenderers advising that the closing time for tender response had been extended to 7 August 2017. Tenderers were not informed of the reason for the extension. In December 2022 Defence informed the ANAO that it was unable to locate any documented reason or approval to extend the RFT. All three participants submitted their tenders by 7 August 2017.

2.24 During the RFT process, Defence issued 16 addenda to the tenderers between 7 April 2017 and 28 July 2017. All tenderers were informed of amendments to the RFT documentation at the same time.

Evaluation criteria

2.25 The EtP set out 10 agreed tender evaluation criteria and ‘considerations including value for money’. These considerations included five project objectives that ‘have been developed [to] identify what is required to deliver the outcomes sought by the Government.’ The objectives were:

• deliver nine Anti-Submarine Warfare Frigates (Ships) based on a Military-Off-The-Shelf design with a minimum level of change;
• contribute to a Continuous Naval Shipbuilding industry in Australia;
• maximise Australian Industry Capability;
• commence construction in Adelaide in 2020; and
• remain within the provision⁴⁸ of the Integrated Investment Program (IIP).⁴⁹

2.26 The objectives aligned with the evaluation criteria, as shown in Figure 2.1 below. The 23 high-level capability requirements (discussed in paragraph 2.16) were included under the ‘tendered mission system will meet the Commonwealth’s capability requirements’ evaluation criterion.

Figure 2.1: Alignment of project objectives and tender criteria

Source: ANAO analysis of Department of Defence documents.

2.27 In the EtP, Defence documented an assessment of the risks to each of the five project objectives and the risk treatments.

• Three project objectives were assessed as high risk. These were: ‘to deliver nine Anti-Submarine Warfare Frigates (Ships) based on a Military-Off-The-Shelf design with a minimum level of change’; ‘contribute to a Continuous Naval Shipbuilding industry in Australia’; and ‘remain within the provision of the Integrated Investment Program’.
• Two project objectives were assessed as medium risk. These were: ‘maximise Australian Industry Capability’; and ‘commence construction in Adelaide in 2020’.

2.28 Enclosures to the EtP included signoffs from the probity advisor for the project (the Australian Government Solicitor, AGS)⁵⁰ and the legal advisor for the procurement (Ashurst). In summary, the legal advisor did the following.

• Noted risks with regards to the RFT approach, including the lack of a statement of work⁵¹, operational and performance specification documents, and limitations to the achievement of tender quality pricing.
• Indicated that given this approach, the tenders would not represent binding offers from the participants to enter into a contract, that were capable of acceptance by the Commonwealth. The tenders would instead include a range of information and proposals that could, with further negotiation and development, form the basis of a binding offer in due course.
• Noted uncertainties regarding the shipyards, workforce arrangements, combat management system, some aspects of continuous naval ship building and Australian Industry Capability, and pricing risks.

2.29 The RFT also outlined key assumptions for the tenderers to rely on for the purpose of developing their tenders, as outlined in Table 2.1. These assumptions aligned with areas of uncertainty identified by the legal advisor in reviewing the EtP.

Table 2.1: Key Assumptions in the Request for Tender

Note a: Following the release of the RFT, two of the five key assumptions changed. The Osborne shipyard was specified as the location of construction. Defence introduced the purchase of ASC Shipbuilding as a contractual requirement, as noted at paragraph 1.13.

Source: Department of Defence.

Tender Evaluation Plan

2.30 Defence’s 2016 Defence Procurement Policy Manual — which was in effect at the time the Tender Evaluation Plan (TEP) was developed — provided that tender evaluation plans must be prepared for all complex procurements and all military significant procurements as part of a major or minor project. The TEP was expected to be ‘the planning and control document for the management and conduct of the tender evaluation’.

2.31 The Future Frigate TEP was signed on 7 August 2017, the day the tender closed, by the Acting Director-General Future Frigates (acting SES Band 1/one-star equivalent). The plan established the Tender Evaluation Organisation (see Figure 2.2 below) and an Expert Advisory Panel.⁵²

Figure 2.2: Elements of the Tender Evaluation Organisation

Source: ANAO analysis of Department of Defence documents.

2.32 The Future Frigate TEP set out roles, responsibilities, and the process to be followed for the evaluation of tenders (including tender registration, managing late tenders, conducting an initial screening process, and rules regarding access to tenders). Regarding the assessment of value for money of the tenders received, the TEP stated that:

The TEP does not require the Tender Evaluation Organisation (TEO) to conduct a comparative evaluation of tenders and to determine a ranking of tenders based on a value for money assessment of the tenders. Rather the TEO is to provide Government with its assessment of the acceptability to the Commonwealth of the tenders against each of the evaluation criterion. Using the acceptability assessment it is proposed that Government will consider the value for money of the tenders.

2.33 AGS provided a formal sign-off for the TEP, stating that it had identified ‘no probity or legal process issues with the contents of the Evaluation Plan’. Previously, AGS had provided input on the lack of a process for assessing value for money in the draft TEP (dated 2 March 2017).

We understand that the TEP [Tender Evaluation Plan] does not require the TEO to make a value for money assessment. As this is a procurement process, a VFM [value for money] decision will need to be made at some level of government – in our view this process should be outlined in the TEP. We suggest that the intended process to be undertaken be explained in the TEP. If there is a more detailed process to be conducted within government for the selection of the preferred tenderer then we suggest that it be detailed in the TEP.

2.34 The TEP did not document how the evaluation process would address the core rule of the Commonwealth Procurement Rules (CPRs) — achieving value for money — other than to say that ‘it is proposed that Government will consider the value for money of the tenders’. Paragraph 4.4 of the March 2017 CPRs, which applied at the time, provided that: ‘Achieving value for money is the core rule of the CPRs. Officials responsible for a procurement must be satisfied, after reasonable enquires, that the procurement achieves a value for money outcome [emphasis in original].’ Further, the ‘Defence Procurement Policy Manual 2016’, which applied at the time, reiterated the CPR requirements and highlighted the requirement for comparative analysis of costs and benefits in assessing value for money:

The CPRs provide that Value for Money is the core principle underpinning Australian Government Procurement and the application of this principle requires a comparative analysis of all relevant costs and benefits of each proposal throughout the whole procurement cycle (whole-of-life costing).

Value for Money is not limited to a consideration of capability versus price, or ‘cheapest price wins.’ Value for money requires consideration of Australian Government policy, specifically values such as open competition, efficiency, ethics and accountability. The CPRs outline these policies in further detail. Officials conducting procurement should be aware that the overall goal of the procurement process is to provide a value for money recommendation to the delegate. [emphasis in original]

2.35 Defence did not document the rationale for the Future Frigate TEP not requiring a value for money assessment, comparative evaluation of the tenders, or ranking of tenders.⁵³ This was a further shortcoming in record-keeping for the procurement. There is no Defence record of the department seeking advice from the Department of Finance on its selected procurement approach and compliance with the CPRs.

Assessment against the Tender Evaluation Plan

2.36 Tenders were assessed in accordance with the Tender Evaluation Plan (TEP) following the close of the request for tender (RFT) on 7 August 2017.

2.37 The Source Evaluation Report⁵⁴ was approved by the delegate (Deputy Secretary, Capability Acquisition and Sustainment Group) on 13 December 2017. The report set out the Tender Evaluation Board’s overall assessment of tender compliance⁵⁵ and risk⁵⁶ for each of the 10 criteria outlined in the RFT and TEP. All tenderers were found to be ‘acceptable with changes’, with tenders largely meeting compliance requirements and resulting in a combination of medium–high risks across most criteria, with two extreme risks identified in the assessment of the BAE Systems’ Type 26 design. A summary of the results is set out in Table 2.2.

Table 2.2: Summary of the overall assessment of tender compliance and risk

Source: Defence.

2.38 In accordance with the TEP, the Source Evaluation Report did not include a value for money assessment and did not recommend a preferred tenderer.

2.39 Following the 13 December 2017 delegate approval of the Source Evaluation Report, the probity advisor (AGS) issued a probity sign-off on 21 December 2017, confirming that from a probity perspective the assessment of tenderers in the Source Evaluation Report was ‘fair and defensible’. Defence should have ensured that the probity sign-off was available to the delegate (the Deputy Secretary CASG) at the time of the delegate’s consideration of the tender evaluation report.

Offer Definition and Improvement Activities

2.40 Prior to finalisation of the Source Evaluation Report (SER), Defence commenced Offer Definition and Improvement Activities with all three tenderers. The SER contained advice to the SER delegate (the Deputy Secretary, Capability Acquisition and Sustainment Group) that:

With the approval of the SER delegate, the Project has entered into Offer Definition with all three tenderers prior to Second Pass. Offer Definition will be used to further explore key issues and risks identified in tender evaluation, and seek to mitigate short term Project risks.

2.41 The SER delegate’s approval to proceed with offer definition activities was provided by email on 30 November 2017, with Defence commencing offer definition activities with all three tenderers on the same day.

2.42 An Offer Definition Plan was approved on 1 December 2017 by the offer definition delegate, the Director-General Future Frigates (SES Band 1/one-star equivalent). The plan stated that the objectives of the Offer Definition and Improvement Activities were to:

• improve and maximise value for money, which is achieved through competitive tension and providing feedback on selected aspects of the tendered offers;
• enable the tenderers to better understand Defence’s requirements and Defence to better understand the tenders, with the aim of refining the products to be contracted;
• minimise risk, by giving the Commonwealth the opportunity to identify and agree potential risk treatments with each tenderer; and
• progress contract documents so the Commonwealth and any subsequent preferred tenderer will have fewer issues to resolve during contract negotiations in the lead up to contract signature.

2.43 Tenderers provided offer definition responses between 12 December 2017 and 28 February 2018. Defence reported the outcomes of the offer definition process in a ‘Source Evaluation Report Supplement’. That report provided a further assessment of each tenderer against eight of the 10 tender evaluation criteria and highlighted six areas of change between the Source Evaluation Report and the offer definition outcomes.⁵⁷ The report concluded that the overall assessment of tenderers remained unchanged and all tenders had ‘the potential to achieve the project objectives, but with different strengths and weaknesses, and areas of discrimination.’⁵⁸

2.44 On 9 April 2018, the Source Evaluation Report Supplement was finalised by the Project Director. Defence has not retained a record of the approval of this report by the offer definition delegate or the Source Evaluation Report delegate.⁵⁹ Further, the Source Evaluation Report Supplement did not include a value for money assessment (which had been identified as an objective of the Offer Definition and Improvement Activities) or recommend a preferred tenderer. As discussed in paragraphs 2.32 to 2.35, the approach to tender evaluation adopted by Defence was not consistent with the CPRs or the Defence Procurement Policy Manual 2016, which applied at the time. Further, and as discussed in paragraphs 2.7 to 2.9, these and other shortcomings in record-keeping raise issues of transparency, accountability and non-compliance with the CPRs and Defence Records Management Policy.

2.45 The probity advisor (AGS) signed off the Source Evaluation Report Supplement, confirming that: the evaluation of Offer Definition deliverables had been conducted in accordance with the Offer Definition Plan, RFT and the Tender Evaluation Organisation; and that the assessment in the Source Evaluation Report Supplement was ‘fair and defensible’ from a probity perspective. The AGS sign off did not include commentary in relation to value for money.

Management of probity

2.46 The November 2016 Legal Process and Probity Plan reflected the procurement approach agreed by the government in April 2016 and set out ethical and probity standards to be followed by Defence officials. The Director-General Future Frigates was responsible for ensuring compliance with the plan. The plan set out the following.

• Applicable legislative and regulatory requirements (such as the Defence Accountable Authority Instructions made under the PGPA Act).
• Instructions on how to work with tenderers.⁶⁰
• Responsibilities for the identification and management of conflicts of interest.
• Records management responsibilities, including the maintenance of a register of conflicts of interest, a register of gifts and hospitality⁶¹, and an audit trail.

2.47 Defence’s probity register recorded that 1571 officials received a probity briefing or returned a conflict of interest declaration between February 2016 and January 2019. The register did not contain sufficient information to determine whether all members of on-site liaison teams received probity training or briefings prior to commencing their roles. For the 1571 entries, ANAO analysis indicates the following.

• There were 72 instances of a conflict of interest or confidentiality declaration not being completed. For these 72 cases, there were 52 instances where document management system access was reported as being removed and 20 instances where there is no report of action taken.
• There were 32 instances where a probity briefing was not recorded. For these 32 cases, there were 28 occurrences reported of the person’s access being removed.⁶² There were four instances of personnel not completing a required probity briefing and not being recorded as having their access removed.

2.48 Defence recorded interactions between Defence officials and tenderers or other relevant parties between August 2016 and November 2018 on a register of communications. The project register included a gift register (which was a subset of the communications register) with six entries. Five of the six entries were for gifts received by the on-site liaison teams and one entry was for a gift received by the Project Director.⁶³ ANAO review of Defence records identified that BAE Systems notified Defence that it provided hospitality valued at AUD $340 to the General-Manager Ships and Director-General Future Frigates. Receipt of this hospitality was not recorded by Defence in the project register or the departmental gifts and benefits register.⁶⁴ There is no record of Defence’s management of probity in relation to this event.

Management of probity issues

2.49 During the competitive evaluation process, the probity advisor (AGS) provided advice on a range of topics including conflicts of interest, protocols for the on-site liaison teams, communication with tenderers, the tender evaluation process, media, and requests for information.

2.50 Defence records show that five of the eight recorded probity issues had been reported to the Project Director by project staff.⁶⁵ Of the remaining three incidents⁶⁶, AGS was aware of two incidents. The remaining incident was reported through the SEA 5000 probity mailbox.⁶⁷ These probity incidents and their treatments were not recorded in any register.

2.51 In signing off the competitive evaluation process, the probity advisor reported to Defence that:

Key legal process and probity issues, such as identifying and managing conflicts of interest, ensuring the fair and equitable treatment of tenderers, and ensuring the protection of confidential information have, in our view, been managed appropriately throughout the CEP.

Did Defence effectively advise government?

Advice provided to government at ‘first pass’

2.53 In April 2016, Defence provided sufficient advice on risk, cost and schedule to inform the Government’s decision to proceed to the competitive evaluation (also see paragraphs 2.16 to 2.17). The advice addressed the following.

• Project risk — Defence acknowledged that the project was high risk, and that schedule and design change risks were rated as extreme (given the commitment to cut steel in 2020).
• Budget — costs would be managed within the Integrated Investment Program, without increasing schedule risk.⁶⁸ Defence advised that it would return to the Government if trade-offs between costs and capability were required.
• Design risks — stemming from the three ship designs having different design maturity risk and that all would require redesign work.⁶⁹
• Industry engagement — Defence advised that due to the accelerated schedule of the competitive evaluation process, there had not been direct industry engagement to support cost quality.⁷⁰

2.54 In outlining the competitive evaluation process, Defence noted that the government would decide the design that best met requirements in terms of construction start date, capability requirements, design changes and value for money. This approach to determining value for money had been included in the Tender Evaluation Plan (TEP) discussed in paragraph 2.31.

2.55 As noted in paragraph 2.7, Defence has not retained full records outlining the rationale for the selection of the designs that were put forward for the government’s agreement as part of first pass approval.

2.56 In relation to the cost estimates advised to government, the advice noted that acquisition costs were based on estimates developed for the Force Structure Review. A paper on the draft Defence advice, prepared by Defence’s Contestability Division, noted that:

the estimate does not meet the cost quality normally required for First Pass approval by the Estimates Memorandum agreed with Finance …

Only around 18% of the estimate, rather than around 80% that would usually be expected, is of the appropriate quality. In light of the time constraints it is unlikely that this can be substantially improved. Senior engagement with the Department of Finance will likely be necessary.

Development of advice for ‘second pass’ government approval

2.57 The purpose of second pass is to achieve endorsement by government of a specific capability solution and funding for its acquisition. To develop its advice to government, Defence drew on its assessment of tendered designs against key elements of the government-approved capability requirements. The advice was developed by the Navy and was reviewed internally by Defence senior committees and externally by the Secretaries’ Committee on National Security⁷¹ prior to submission to government. The timeline of tender assessments and decision points is set out in Figure 2.3 and discussed further below.

Figure 2.3: Timeline of tender assessments and key decision points

Source: ANAO analysis of Defence documentation.

Capability Management Steering Group (CMSG)

2.58 To develop advice and a recommendation, the Chief of Navy convened four meetings of a Future Frigate Three-Star Capability Management Steering Group (CMSG) between 5 December 2017 and 14 February 2018.⁷²

2.59 At its first meeting (5 December 2017), the CMSG agreed that its advice and recommendation would be based on an assessment against the government’s 23 high-level capability requirements.⁷³ The CMSG also agreed to seek additional information from tenderers and partner navies.

2.60 The project probity advisor (AGS) advised Defence that ‘accepting and considering additional information as part of the RFT evaluation process would … constitute bid repair’ and that Defence ‘could be seen to have acted inconsistently with the RFT Conditions of Tender released to the Tenderers’.⁷⁴ Defence nonetheless approached two tenderers for further information, and considered the additional information as part of the CMSG’s deliberations. Defence advised the ANAO in April 2023 that it was not able to locate a response to the AGS advice.

2.61 The CMSG’s minutes show that it had intended to incorporate the outcomes from the Offer Definition and Improvement Activities. On 20 February 2018, prior to the receipt of all Offer Definition and Improvement responses by Defence (see paragraph 2.43), the Chief of Navy approved recommendations to be made to the Defence Investment Committee.

Defence Investment Committee (DIC)

2.62 On 2 March 2018 the Chief of Navy presented to Defence’s Investment Committee (DIC) on the tender process, project timeline and the key differences between the tendered options, but did not address value for money nor make a recommendation on the preferred tenderer. Further, the papers presented to the DIC, which included draft advice to government, did not identify a preferred tender or address value for money. An attachment to the Chief of Navy’s paper stated that the Chief Financial Officer was ‘aware of the project’s financial position but as the offer definition updates have not yet been received, a full costing review has not occurred.’

2.63 At its 2 March 2018 meeting the DIC noted the assessed cost and schedule risks and levels of compliance against requirements for the tendered design and agreed to present BAE’s ‘Global Combat Ship – Australia’ as the preferred option to the Defence minister and the government. The outcomes (minutes) of the DIC meeting did not refer to the tender evaluation outlined in paragraphs 2.36 to 2.45, the assessments made in the Source Evaluation Report, or the Source Evaluation Report Supplement. Further, the DIC outcomes (minutes) did not document consideration of whether the ‘Global Combat Ship – Australia’ represented value for money for the Commonwealth.

Defence Committee (DC)

2.64 DIC records indicate that draft advice to government was to be considered by the Defence Committee (DC) on 15 March 2018. The DC is the most senior enterprise-level committee within Defence.

2.65 On 15 March 2018 the DC considered a presentation with summary information on the tendered offers and draft advice to government, as endorsed by the DIC, which included the identification of BAE as the preferred tender.

2.66 The minutes of the DC’s 15 March 2018 meeting were not retained.⁷⁵ In the absence of these minutes, it is unclear what deliberations took place. A senior Defence official’s hand-written notes of the relevant 2018 DIC and DC meetings indicate that the discussions focused on capability and Australian shipbuilding industry considerations. The hand-written notes did not include references to the relative value for money of the tenders.⁷⁶

Meetings with ministers and secretaries

2.67 On 4 May 2018, Defence officials met with the Prime Minister, the Minister for Defence, the Minister for Defence Industry and the Secretary of the Department of the Prime Minister and Cabinet. At the meeting, Defence undertook to review options for ‘commercial and company structures associated with the successful tenderer and resultant enduring Australian sovereign naval ship building base’.⁷⁷

2.68 On 10 May 2018 Defence presented its draft second pass advice to the Secretaries’ Committee on National Security. The committee noted the key issues discussed at the meeting with Ministers on 4 May 2018 and agreed that Defence’s advice proceed, with amendments, to the government for consideration.

Advice provided to government at ‘second pass’

2.69 To support the government’s decision-making, Defence provided advice on the preferred capability, cost, schedule and risk. Defence did not provide advice on value for money.

Advice on preferred capability

2.70 Defence recommended that the government select BAE Systems’ ‘Global Combat Ship – Australia’ as the preferred capability.

2.71 The rationale for the recommended selection was clearly documented in the advice to government and was based primarily on anti-submarine warfare capability as the key discriminator. The focus on anti-submarine warfare capability aligned with the project objective, approved by government, to deliver nine anti-submarine frigates (see paragraph 2.25). Anti-submarine warfare capability was also one of the 23 high level capability requirements assessed in one of the ten tender evaluation criteria, under ‘Tendered Mission System (see Table 2.2).

2.72 Defence advised the government that it had selected mature designs for consideration. The advice noted that Defence had assessed the three tenders against the 23 high-level capability requirements and project objectives and that the key differentiator between the tenders related to anti-submarine warfare capability. An attachment to the advice included Defence’s comparison of the tenderers against the high-level capability requirements. This comparison differed from the assessments made by the Future Frigate Three-Star Capability Management Steering Group (the CMSG, discussed in paragraph 2.58). The source document for this attachment has not been retained by Defence. Defence advised the ANAO in September 2022 that it was unable to locate records of its assessment (prepared during the tender evaluation) against the 23 high level capability requirements.

2.73 Defence’s assessment against the high-level capability requirements, as provided to government, did not include an assessment against the capability requirement relating to the maturity of the ship designs. However, the second pass advice noted that ‘BAE Systems has only recently commenced construction on the UK [BAE Type 26⁷⁸] program’ and that the Type 26 ‘does not yet represent a ship in water…the design is not yet complete.’ Defence’s advice also noted that the ‘UK expects a (Type 26) ship acceptance date (post contractor sea trails) in 2023 and they advise that the project is on track to meet this milestone’.

2.74 Defence has previously responded to ANAO observations that the shortlisting of the BAE offering did not appear to be consistent with the principles regarding design maturity in the RAND report on Australia’s Naval Shipbuilding Enterprise: Preparing for 21^st Century. In November 2017, during the performance audit resulting in Auditor-General Report No. 39 2017–18 Naval Construction Programs—Mobilisation, Defence advised the ANAO that:

The three designs are considered military-off-the-shelf with the T26 [BAE Type 26] having just started construction in the UK. The RAND analysis completed in 2015 noted “numerous data unknowns” for this platform however UK MoD [Ministry of Defence] has now shared the relevant protected data to the SEA5000 project.⁷⁹

2.75 The maturity of the BAE Type 26 reference ship design is discussed further in paragraphs 3.98 to 3.117 of this audit report.

2.76 Defence’s advice to government also noted that the tenderers had agreed in principle to the ASC transaction at a nominal cost of $1.00.

Advice on cost

2.77 In its advice to government at second pass, Defence noted that all three tendered options were unaffordable within the Integrated Investment Program (IIP) provision ($36.4 billion), with a four per cent difference in cost between the three options. Defence advised the government that project costs (estimated at $44.3 billion) would be managed within the provisions of the future naval construction program.⁸⁰ Defence provided the government with a rough order of magnitude whole-of-life cost estimate for BAE Systems’ tender.⁸¹

2.78 The acquisition cost estimate provided in the advice included a 10 per cent cost reduction to the tendered production costs, valued at $2.1 billion. Defence did not document the basis for this advice and did not disclose, in the advice, that a cost reduction had not been negotiated with the tenderers. An assessment of project cost estimates undertaken by Defence’s Contestability Division in April 2018 had considered the 10 per cent reduction and noted that:

it could be argued that there is an opportunity for these costs to reduce. However there is no clear evidence either from the Department of Defence experience in shipbuilding projects, nor the broader cost analysis literature to support this. There is significant discussion in the cost literature to support the opposite — initial cost estimates tend to be overly optimistic resulting in future cost increase.

The reduction in the total acquisition estimate by this amount is a cost risk to the project and increases the likelihood that during future submissions to government the build cost will increase from this base cost.

2.79 The Department of Finance (Finance) prepared an assessment that was included in the draft advice provided by Defence to its ministers at second pass. Finance drew attention to the 10 per cent cost reduction on the tendered production costs⁸² and what it considered to be limitations in Defence’s advice on cost. Finance noted that a sustainment provision had been provided in place of a sustainment cost estimate and that the requirement in the Budget Process Operational Rules applying to Defence had not been met.⁸³ Finance also noted that the selection of the preferred tenderer was based solely on capability, in the absence of whole of life cost estimates.

2.80 Finance supported Defence’s recommendations to government, noting that over the life of the project Defence would return with further cost estimates and submissions for future project stages. That is, there would be further opportunity to refine the costs presented to government. Finance did not comment on Defence’s approach to the procurement or lack of value for money assessment.⁸⁴

2.81 Defence provided the ANAO with a number of spreadsheets that the department stated formed the basis of the tender assessment and consideration, and which contained cost information for government’s consideration at second pass. The spreadsheets contained detailed information and formulae across thousands of cells. Most of these documents were not finalised in Defence’s records management system, and the document history recorded in the Defence records management system indicates that all had been edited following the government’s selection of the preferred tender.

Advice on capability transition and schedule

2.82 Defence advised the government at second pass that the ANZAC class frigate transition plan was under development and that the first ANZAC class frigate was expected to retire between 2030 and 2043.⁸⁵

2.83 Defence also noted that overall project risk was high, with schedule risk assessed as high due to construction of the BAE Type 26 commencing in the UK in 2017.

Government second pass decision

2.84 At second pass in June 2018, the government agreed to:

• the selection of BAE Systems’ ‘Global Combat Ship – Australia’ as the design for the Future Frigate;
• the sale of ASC Shipbuilding to BAE Systems;
• funding of $6,725.6 million (out-turned)⁸⁶; and
• Ministers progressively returning to government to seek approval for the funding of construction of successive batches of three ships per batch.⁸⁷

2.85 In summary, Defence’s advice to the Australian Government at second pass on the selection of the preferred ship design did not include an assessment of value for money or include whole-of-life cost estimates as required by the Budget Process Operational Rules applying to Defence. These are long-established requirements for well-informed government decision-making and are intended to provide Parliament and the community with confidence regarding the proper use of public resources. As discussed in the next section, Defence’s procurement and related advisory processes did not include a value for money focus, and this approach did not comply with the core rule of the Commonwealth Procurement Rules (CPRs), which state that:

4.4 Achieving value for money is the core rule of the CPRs. Officials responsible for a procurement must be satisfied, after reasonable enquiries, that the procurement achieves a value for money outcome [emphasis in original].

Consideration of value for money in the procurement

2.86 In its December 2022 response to the ANAO’s preliminary audit findings, Defence advised that it did not agree that the procurement lacked a value for money focus. Defence informed the ANAO that:

The value for money assessment is inherent throughout Defence’s management of the naval shipbuilding enterprise and, through this lens, the progress of the project between first and second pass. Defence recognises that value for money is not solely determined by the price. Key assessments in determining value for money commenced with the work RAND Corporation undertook in 2015 (Australia’s Naval Shipbuilding Enterprise – Preparing for the 21^st Century). This work underpinned the Government of the day taking a more strategic approach to establish continuous naval shipbuilding programs and a more structured approach to through-life management. This was announced in the 2016 Defence White Paper and later expanded in the 2017 Naval Shipbuilding Plan. In essence, the Government determined there to be value for money in establishing a sovereign, sustainable, cost-competitive continuous shipbuilding program in Australia.

2.87 This response was repeated in substance and expanded on in Defence’s formal response to the audit report, reproduced at Appendix 1:

The goals and purpose underpinning the planned procurement of nine future frigates was clearly enunciated in the 2016 Defence White Paper and the 2017 Naval Shipbuilding Plan.

…

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.

2.88 Two key propositions in Defence’s responses to the ANAO are inconsistent with the long-standing requirements of the Commonwealth procurement framework. These propositions are that:

• ‘The value for money assessment is inherent throughout Defence’s management of the naval shipbuilding enterprise …’; and
• ‘the Government determined there to be value for money in establishing a sovereign, sustainable, cost-competitive continuous shipbuilding program in Australia.’

2.89 In its responses, Defence has conflated an industry policy objective (establishing a continuous naval shipbuilding program in Australia) with the achievement of value for money in procurement as required by the Commonwealth Procurement Rules (CPRs) — in effect arguing that a procurement undertaken to help effect this policy objective will necessarily represent value for money.

2.90 As noted in paragraph 2.1, an entity’s accountable authority has a duty, under paragraph 15(1)(a) of the Public Governance, Performance and Accountability Act 2013 (PGPA Act) to promote the proper (efficient, effective, economical and ethical) use and management of public resources in accordance with the PGPA Act, including by complying with the CPRs. The accountable authority of a non-corporate Commonwealth entity (such as Defence) must also govern the entity in accordance with paragraph 15(1)(a) in a way that is not inconsistent with the policies of the Australian Government. In the procurement context, this means that government policy may be a relevant consideration in the assessment of value for money under the CPRs.

2.91 The CPRs are a legislative instrument issued by the Minister for Finance under the PGPA Act. The core rule of the CPRs is achieving value for money, regardless of the type of procurement process undertaken, such as a limited tender as in this case. Paragraph 4.4 of the CPRs states that:

4.4 Achieving value for money is the core rule of the CPRs. Officials responsible for a procurement must be satisfied, after reasonable enquiries, that the procurement achieves a value for money outcome [emphasis in original].

2.92 This is, in effect, an obligation on officials to assess value for money. The obligation on officials cannot be excluded from a procurement process, as in the 2017 Tender Evaluation Plan (TEP) for this procurement. Defence’s TEP, discussed in paragraphs 2.31 to 2.35, stated that:

The TEP does not require the Tender Evaluation Organisation (TEO) to conduct a comparative evaluation of tenders and to determine a ranking of tenders based on a value for money assessment of the tenders. Rather the TEO is to provide Government with its assessment of the acceptability to the Commonwealth of the tenders against each of the evaluation criterion. Using the acceptability assessment it is proposed that Government will consider the value for money of the tenders.

2.93 Paragraph 2.2 of the CPRs provides that officials from non-corporate Commonwealth entities (including Defence) must comply with the CPRs when performing duties related to procurement. These specific requirements are underpinned by sections 25–29 of the PGPA Act, which impose a set of general duties for officials of Commonwealth entities. The general duties include the consideration of, and where relevant, compliance with the finance law, which includes the PGPA Act and PGPA Rule and instruments made under the PGPA Act, such as the CPRs.⁸⁸

2.94 The CPR requirements are reflected in paragraphs 6 and 7 of the Defence Procurement Policy Manual (DPPM), which reinforces the CPR requirement to assess value for money in all procurements and the obligation on officials to do so:

Division 1 of the CPRs (in Chapter 4 of the DPPM) sets out rules that apply to all procurements. This means that all Defence procurements are required to comply with Division 1 (and the additional Defence Procurement Policy Directives in Chapter 4 of the DPPM). This Division establishes ‘value for money’ as the core requirement of Commonwealth procurement. Defence officials responsible for a procurement need to be satisfied, after reasonable inquiries, that the procurement achieves value for money.⁸⁹

2.95 Further, there is no evidence in relevant Australian Government policy statements to suggest that the government expects anything other than value for money to be achieved in the context of Australian naval shipbuilding.

2.96 The 2016 Defence White Paper noted that:

The Government requires Defence to be a smart buyer to maximise Defence capability and value for money for the Australian taxpayer.⁹⁰

…

Efficient capability planning and procurement processes within Defence will ensure that the ADF has the capability it needs when it needs it, and the value for money Australia receives from its investment in Defence is maximised.⁹¹

2.97 The 2017 Naval Shipbuilding Plan noted that:

If the Government is to ensure that the future Australian Defence Force remains a balanced force, with the highest levels of capability and protection our nation can afford, our industry base must deliver capability that is value for money and cost-competitive.⁹²

…

The Government will support the growth of a secure and sustainable Australian naval shipbuilding and sustainment industry through:

a. Careful management of the demand to meet both industry capacity and the Navy’s strategic capability needs (Chapter Two);

b. Decisions on acquisition strategies that balance long-term program vision with value for money project development and program execution risk management, ensuring the Government supports the growth of a sustainable, cost-competitive naval shipbuilding sector.⁹³

2.98 Auditor-General performance audits since 2016–17 (listed at paragraph 1.18), relating to naval shipbuilding procurements, have observed Defence activities to comply with the requirement to assess the achievement of value for money.

• Defence’s competitive evaluation plan for the Future Submarine noted that the early selection of an international partner would support the achievement of value for money, as required for a procurement conducted under the CPRs.⁹⁴
• Defence’s competitive evaluation process for the Offshore Patrol Vessel (OPV) program was supported by appropriate governance, assurance and probity arrangements and a Tender Evaluation Plan that was applied consistently across the three invited tenders, to provide a basis for assessing value for money.⁹⁵ In contrast to the Hunter class frigate tender, the OPV Tender Evaluation Plan included the comparison of tenders and the making of a source evaluation recommendation to the Delegate.⁹⁶ The OPV Source Evaluation Report contained clear value for money assessments, comparisons and rankings.
• Defence’s sole source procurement of six evolved Cape Class patrol boats included two assessments of value for money and the advice to government included Defence’s assessments of value for money.⁹⁷

2.99 Defence’s general approach to applying the CPRs and the core principle of value for money in the Hunter class procurement, and the lack of understanding of CPR requirements reflected in its responses to the ANAO, 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, the Department of Finance, to ensure that procurement activity for major capital acquisition projects is compliant with both the letter and the spirit of the Commonwealth procurement framework.⁹⁸

2.100 The hallmark of Defence’s management of this procurement and related advisory processes is that they lacked a value for money focus, and in that sense the procurement did not comply with the core rule of the CPRs. The origins of this approach — which was reflected in the 2017 Tender Evaluation Plan — are not transparent, due to the shortcomings in Defence record keeping observed in this audit. As discussed in paragraphs 2.7 to 2.12, Defence’s record keeping was not fully consistent with the CPRs, which state that maintaining records is one of the fundamental elements of accountability and transparency in procurement.

3.1 On 14 December 2018 Defence entered into a head contract with ASC Shipbuilding, now trading as BAE Systems Maritime Australia (BAESMA), for the procurement of Hunter class frigates. The design and productionisation stage of the contract at contract execution was valued at $1,904.1 million (GST exclusive). Effective management of the contract, to deliver the contracted objectives, involves:

• fit-for-purpose contracting arrangements to support management of contractor performance⁹⁹;
• contract monitoring and reporting arrangements that ensure adequate visibility of performance and emerging risks and issues to aid decision-making; and
• delivery of project milestones on time and budget to achieve the value-for-money outcomes expected under the contract.

Did Defence establish fit-for-purpose contracting arrangements?

3.2 Following the government’s selection of the Global Combat Ship–Australia design in June 2018, in September 2018 Defence entered into an advanced work arrangement contract with BAE Systems to support the commencement of work prior to finalisation of the head contract. The advanced work arrangement covered the development of key plans and reports, mobilising staff, establishing supply chain arrangements and progressing the Hunter class design.

Head contract negotiations

3.3 Defence held negotiations for the head contract between October and December 2018. The negotiation process was guided by the following.

• An overarching Contract Negotiation Strategy, approved by the General Manager, Ships (SES Band 2/two-star equivalent) on 30 August 2018, which documented the intended contracting approach timeframe and phases. The strategy noted the need to ‘set the foundation for the mutually-beneficial relationship that can be built upon by subsequent generations of project personnel to meet and exceed the parties’ objectives’.¹⁰⁰
• A Contract Negotiation Directive, endorsed by the Director-General, Combat Management and Payload Systems (SES Band 1/one-star equivalent) on 10 October 2018. The Directive established the role of the lead negotiator, negotiation secretariat and work groups to support the negotiation process.

3.4 Defence engaged contractors as the Lead Negotiator and Deputy Lead Negotiator.¹⁰¹ Both their contracts concluded before the negotiation was completed, and the General Manager, Ships approved replacing the Lead Negotiator with a Defence official (Executive Level 2) to complete the final seven days of negotiation on the Commonwealth’s behalf.

3.5 The ANAO reviewed the endorsed Contract Negotiation Directive dated 10 October 2018, which set out 35 negotiation topics and the Commonwealth’s positions.¹⁰² The Commonwealth’s negotiation positions were documented for 34 of the 35 topics.¹⁰³ The sources and rationale behind the negotiation positions were not clearly identified in the directive. For the 34 topics with documented negotiation positions, Defence provided:

• clear and defined directions on its preferred position for 24 topics and did not state a preferred position for 10 topics¹⁰⁴; and
• clear and defined directions on its minimum position for five topics — there were 17 topics with a minimum position that was largely the same as the preferred position and 12 topics did not have clear and defined minimum positions.¹⁰⁵

Negotiation outcomes

3.6 The Contract Negotiation Report, dated 11 December 2018, outlined the negotiation outcomes for 37 negotiation topics and listed 18 negotiation outcomes as ‘significant’. Negotiation topics in the report did not fully align with those listed in the Contract Negotiation Directive.¹⁰⁶

3.7 The Contract Negotiation Report did not state whether Defence’s preferred or minimum position for each topic was achieved. The report noted one instance where Defence achieved less than its minimum position.

3.8 Ten negotiation issues were not finalised at contract execution, including the Continuous Naval Shipbuilding Strategy.¹⁰⁷ The ANAO’s analysis indicates that the head contract, as executed, reflected the finalised Contract Negotiation Report outcomes.

Establishing the head contract

3.10 A (PGPA Act) section 23 commitment approval for the Hunter class head contract was signed on 12 December 2018 by the General Manager, Ships.¹⁰⁸ The minute seeking section 23 commitment approval included advice regarding value for money and relevant attachments (the Contract Negotiation Report and legal, probity and financial advice). The delegate was advised that the achievement of value for money was supported in the negotiated head contract through the following arrangements.¹⁰⁹

• Commonwealth oversight and control arrangements — including comprehensive access and audit rights, contractual levers to actively control BAESMA’s spending and performance, and pricing models to incentivise BAESMA to remain on budget and schedule.
• Performance monitoring and management arrangements — including Special Performance Requirements which if not achieved would require up to a capped amount of rework costs, and Strategic Performance Measures to moderate fees for management services.
• Liability arrangements — including liability caps, limits to recoverable costs for termination on a walk-away basis and a Deed of Guarantee and Indemnity.

3.11 Defence entered into the head contract for delivery of the design and productionisation phase of the program on 14 December 2018. A contract effective date of 4 February 2019 was set out in the head contract.

3.12 The statement of work in the head contract requires BAE000SMA to:

a. progress design maturity of the Mission System and Support System sufficient to successfully exit the final Production Readiness Review;

b. conduct logistics support analysis to define the Support System up to the equivalent of a Support System Critical Design Review; and

c. conduct prototyping activities to provide increased certainty that the shipyard facilities, production systems and processes, workforce and supply chain and finance systems are capable prior to the commencement of ship construction.

Amendments to the head contract

3.13 The head contract establishes processes for Contract Change Proposals (CCPs). The head contract had been subject to 93 CCPs as of 31 March 2023. Thirty-six of the 93 CCPs (39 per cent) approved by Defence were price impacting, with a total increase in contract price of $693.2 million. This represented a 36 per cent increase to the design and productionisation price, resulting in a total contract price of $2,597.4 million (GST exclusive). The contract price remained within the (PGPA Act) section 23 commitment approval amount as at 31 March 2023.

3.14 The approved price-impacting CCPs related to: shipyard lease costs; ‘Hunter Hobart Harmonisation Mobilisation’¹¹⁰; the Interim Arrangement¹¹¹; removal of the combat management system Australian interface scope; Functional Baseline updates; and incorporation of Australian Industry Capability (AIC) investment funding. In addition, 67 engineering change proposals had been technically endorsed as at 31 March 2023.

3.15 The milestones in the head contract have also been amended. At execution, the head contract included 25 key milestones. As at March 2023, there were 37 key milestones in the head contract (see Appendix 3). The first milestone was paid on contract execution. The remaining milestones have criteria to be met/delivered and due dates.¹¹² The 37 key milestones include clear entry and exit criteria and payment amounts. There are also 75 project delivery milestones, which do not include payments, although some correspond to key milestones.

3.16 As at 31 March 2023, the price of the head contract recorded in AusTender had increased to $2,980.4 million, with nine variations totalling $721.4 million (GST exclusive). The variations amount to an increase of approximately 32 per cent of the original published contract value of $2,259 million. Defence was unable to provide evidence to the ANAO of how it calculated the value of one variation in AusTender with a value of $393,151,056.

3.17 The January 2023 project review by the Surface Ships Advisory Committee (SSAC) identified the following issues with the contract change proposal process:

In previous reviews, the SSAC [Surface Ships Advisory Committee] have expressed concern about the time it takes for Contract Changes (CCPs) to be processed (on HCF [Hunter class frigates] and other projects). Complex Projects like the HCF that span years typically involve hundreds of Contract Change Proposals (CCPs). Following our previous comments, the HCF Project has been working to determine CCP processing timelines and working with BAESMA to understand the process and seek to improve cycle time. They have identified that “simple” CCPs take 6-8 weeks from initial identification/planning to execution while “complex” CCPs take 4-24 months. The SSAC consider this to be excessive and putting additional risk on schedule. The Project/BAESMA team have flow charted the CCP process with all its steps, drafting, multiple reviews and approvals and it appears to us to be far from being a streamlined process. The SSAC recommends that Defence leadership review this process with the HCFP/BAESMA team, identify roadblocks and opportunities for improvement in the process … and the SQEP [suitably qualified experienced people] contracting resources assigned to the Project and BAESMA teams to determine if additional staffing is needed.

The significant changes in the Commonwealth’s (MIWS’) [ Maritime Integrated Warfare Systems] and BAESMA’s roles and responsibilities in the design, development, integration and testing of the HCF CS [combat system] are not fully reflected in the Head Contract. Furthermore, absent the detailed schedules and costings associated with MIWS executing its enhanced roles and identifying the attendant reductions in BAESMA’s Head Contract costs, the net impact has not been determined. Currently, Batch 1 pricing is proceeding on the basis of roles and responsibilities as described in the Head Contract. The SSAC recommends that these changes be agreed and a CCP be incorporated as soon as practicable to remove ambiguity and enable effective scheduling and costing for CS related effort. [emphasis in original]

Performance measures

3.18 The head contract includes performance measures and commercial levers to support Defence’s monitoring and management of BAESMA’s performance.

3.19 The contract states that ‘the purpose of the Performance Measures is to support the Commonwealth to measure the Contractor’s performance against the Contract in terms of achieving the Outcomes.’ Defence has established three Strategic Performance Measures (SPMs) in the head contract which are to be used to measure the contractor’s performance against the Strategic Relationship Principles.¹¹³ The three SPMs are:

• Relationship: BAESMA’s demonstration of positive relationships with the Commonwealth, subcontractors and other third parties.
• Best for Defence: BAESMA’s ability to balance its commercial interests and other interests for the benefit of the project and Defence.
• Data Transparency: BAESMA’s demonstration of full data transparency.

3.20 Two other types of performance measure are to be developed for Batch 1 (the build of the first three frigates). These are Enterprise Key Performance Indicators and Other Performance Measures.

Commercial levers

3.21 Defence has included a range of levers in the contracting arrangements with BAESMA. These include profit moderation, scope adjustment and fee moderation.

3.22 Profit moderation is a key commercial lever that Defence has the option of applying, to ensure BAESMA performs satisfactorily. Defence has agreed a management services fee (an agreed percentage) on the management services component of the contract price, and a scope fee (also an agreed percentage) on the design and productionisation scope component of the contract price. Both fees are to be adjusted to exclude pass through expenses, unrecoverable transaction costs, and allowable costs in respect of long lead time items from the calculation.¹¹⁴ If BAESMA does not meet performance expectations against key milestones, a total of 50 per cent of BAESMA’s scope fee is to be put at risk, with a 10 per cent reduction of the payable fee for every seven-day period beyond the due date.

3.23 Profit moderation of the management services fee was potentially triggered when BAESMA’s performance against the Data Transparency SPM was rated amber (fair) for a second consecutive quarter for the November 2019 to January 2020 period (subsequent to the grace period allowed under the head contract). To trigger profit moderation, Defence would have needed to require a remediation plan from BAESMA. Defence advised the ANAO that no remediation plan had been required as at 20 March 2023.

3.24 The head contract makes provision for the inclusion of stop payment milestones. These provisions are not currently active in agreed contractual arrangements for the design and productionisation stage.

3.25 Defence can terminate or reduce the scope of the head contract, including by terminating a scope and on a walk-away basis, if Defence and BAESMA are not able to agree a scope statement. In terms of scope termination, liability is limited to payments in respect of work performed prior to termination or reduction and directly attributable reasonable costs incurred by BAESMA. The Scope Fee moderation provisions were identified by the Finance sub-Tender Evaluation Working Group as ‘insufficient to positively influence contractor behaviour and will not provide adequate Commonwealth control of Contractor schedule performance.’

3.26 On 29 June 2022 Defence signed a CCP activating profit moderation for Scope Fee from 1 July 2022, enlivening a key commercial lever in the head contract.¹¹⁵ This step was taken as BAESMA did not achieve Integrated Baseline Review 2, which would have otherwise commenced Scope Fee moderation arrangements.

3.27 The head contract does not contain arrangements to manage potential undue benefits to BAE Systems Australia’s sustainment work under the Warship Asset Management Agreement (WAMA).¹¹⁶ A November 2021 review of the program commissioned by the Minister for Defence observed that Defence had ‘minimal leverage over BAE [BAESMA] … which will make it very difficult to maintain commercial pressure over time.’¹¹⁷ These potential limitations of the Commonwealth’s commercial leverage were noted in Auditor-General Report No. 30 2018–19 ANZAC Class Frigates — Sustainment which tabled in March 2019:

In transitioning from the ANZAC class to the Hunter class frigates, Defence’s commercial leverage over BAE Systems for any cost or schedule overruns in the Hunter class design and build, will be limited due to the existing commercial relationship with BAE Systems to sustain the ANZAC class. For example, any liquidated damages applied to BAE Systems for underperformance on the Hunter class program, may be offset by the benefit received by BAE Systems through the extended sustainment of the ANZAC class. The ANAO found no arrangement within the WAMA [Warship Asset Management Agreement] contract to deal with this issue.¹¹⁸

3.28 The head contract does not include liquidated damages clauses or liquidated damages milestones to compensate Defence for costs that may be incurred over the life of the project due to project delays.¹¹⁹ However, the head contract does make provision for applying a fixed price cost model to a future scope (that is, the build scopes) and sets out that liquidated damages will be included in any fixed price model scope.

Has Defence established effective contract monitoring and reporting arrangements?

Contract management plan

3.29 CASG’s Defence Contract Management Handbook sets out that:

The CMP [contract management plan] documents the operational, management and executive governance arrangements for managing performance and risk, provides clarity, accountability and responsibility for both contract governance and administration activities via a RACI [Responsible, Accountable, Consulted and Informed] matrix, and addresses how the relationship with the contractor will be managed as a key enabler to successful contract outcomes.

3.30 Defence’s contract management plan for the head contract was approved on 9 August 2022. This was 44 months (3.6 years) after contract execution. The plan states that:

This Head Contract Management Plan (HCMP) provides direction for the ongoing management of the Head Contract, describing and detailing how it will be governed, managed and administered.

Risk management

3.32 The Defence Capability Manual notes that governance arrangements in the acquisition phase include arrangements for ‘risk management to ensure emerging risks are identified and appropriately treated’. The Capability and Sustainment Group’s (CASG) Capability Acquisition and Sustainment Risk Management Manual mandates that:

There are three key artefacts that need to be established and maintained by projects to capture their risk management activities, comprising:

a. Risk Management Plan (RMP);

b. Predict! (Risk Register); and

c. Contingency Budget Log.

3.33 The Risk Management Plan was first approved on 24 April 2017, with the most recent version approved on 4 October 2022. The plan outlines the governance and reporting arrangements for the management of risks and issues for the project, including roles and responsibilities, assessment and recording, treatment, communication and consultation, monitoring and review, and reporting. Risks are categorised as strategic and tactical.

3.34 Tactical risks are to be managed by CASG in Predict!.¹²⁰ Of the 46 tactical risks recorded in Predict! at March 2023, 12 were rated as ‘High’ and two as ‘Very High’ (pre-treatment).¹²¹ The tactical risks rated as ‘Very High’ at March 2023 were: ‘Total budget for Design and Construct is insufficient’; and ‘Combined capital requirement is not affordable by year’.

3.35 Strategic risks are to be managed by Navy, as the capability owner, in the CapabilityOne system. As at 20 May 2022, 14 strategic risks and one issue were recorded as ‘active’ in CapabilityOne, and seven risks were rated high or higher (pre-treatment). One issue and one risk were rated ‘extreme’ (pre-treatment), as follows.¹²²

• Issue: ‘The acquisition and sustainment of Hunter Class Frigate is not achievable with the allocated funding.’¹²³
• Risk: ‘Current Design and Productionisation scope realises a Batch 1 design that does not form a suitable basis for future batches, given the expectation of further capability insertion into future batches’.¹²⁴

3.36 Agendas and minutes examined by the ANAO indicated that risks were discussed at governance meetings and escalated in accordance with the established arrangements under the risk management plan.¹²⁵

Public reporting

3.37 Defence has reported to the Parliament that as at 30 June 2022:

The Project is currently managing risks and issues at both a strategic and tactical level. Strategic risks and issues … broadly fall under a number of key areas being:

• Ship design maturity;
• System Integration;
• Operating Capability delivered to Navy;
• Industry and Navy workforce;
• Australian Industry Capability; and
• Overall budget affordability.¹²⁶

Establishment of contractual reporting and meeting requirements

3.38 To aid Defence’s monitoring and reporting on contract delivery, the contract requires BAESMA to report regularly to Defence through Contract Status Reports and Earned Value Performance Reports and to attend monthly coordination meetings and quarterly progress meetings with Defence. ANAO review of reports and meeting minutes (see Appendix 4) found that BAESMA has delivered reports as required and meetings had occurred.

3.39 In addition to these standard arrangements, Defence added a requirement to the head contract through the execution of a CCP on 23 March 2022 as a result of BAESMA not submitting a contractible offer for the batch one build scope. BAESMA is required to submit monthly Cost, Risk and Uncertainty Management Reports and attend monthly Cost, Risk and Uncertainty Management Program meetings. The new provisions apply until a batch one build scope is incorporated into the head contract. As at March 2023, BAESMA had submitted 13 Cost, Risk and Uncertainty Management Reports. The thirteenth report covered the February 2023 reporting period and indicated that cumulative reduction of cost risk and uncertainty for batch one was ahead of plan as of February 2023.

3.40 As discussed in paragraph 1.16, the head contract between the Commonwealth and BAESMA commits the parties to work to develop a strategic relationship in accordance with a set of principles. The February 2022 Independent Assurance Review (see paragraphs 3.49 to 3.50) recommended:

A determined effort now to re-set the relationship with BAES [BAESMA], utilising a whole-of-Defence approach to ensure commercial leverage, in order to establish a true strategic partnership, overcome the tensions and adversarial nature of the current engagements, and mitigate the risk of the emergence of the worst features of a monopoly (excessive cost and schedule).

3.41 In March 2022 BAESMA wrote to the Minister for Defence outlining improvement opportunities to the governance arrangements for the program. Opportunities noted by BAESMA included: establishing a ‘Team Hunter’ approach in CASG (an integrated team of CASG, Navy and BAESMA personnel); co-location of the project team at Osborne; establishing an organisation at Osborne empowered to make acceptance, engineering and technical decisions; appointment of an independent chairperson overseeing program performance and reporting directly to the Minister for Defence; and a regular dialogue on the Integrated Master Schedule.

3.42 In July 2022 Defence established a Team Hunter Enterprise Plan comprising 24 initiatives to be implemented by the end of 2022. These included breaking down silos with forums to share information across boundaries, the development of an infrastructure approval process, and streamlining the engineering change process to ensure that necessary change can be efficiently enacted.

3.43 The meeting minutes for the August 2022 monthly coordination meeting noted that the Project Director intended to propose the cancellation of the quarterly progress meetings and six-monthly management reviews. This was due to the introduction of a bi-monthly Joint Program Team Review in June 2022 (quarterly as of December 2022), involving senior representatives of BAESMA and Defence (the First Assistant Secretary (FAS) Ships and the Director-General Hunter Class Frigates). Defence advised the ANAO in December 2022 that it did not intend to amend the head contract to reflect this change:

There is no intention to change the Head Contract. That is, the contractual requirement for a Monthly Coordination Meeting (MCM), Quarterly Progress Meeting (QPM), and Management.

Review (MR) (at intervals of no greater than six months) will not be changed. The contractual requirement is now being met through the:

• CoA [Commonwealth of Australia] attendance at the BAESMA Monthly Business Review (MBR) for the MCM; and
• Conduct of a Quarterly Joint Program Team Review (QJPTR) (attended by MD [Managing Director] BAESMA and FAS MSCCS [First Assistant Secretary Major Surface Combatants and Combat Systems]¹²⁷) for the QPM and MR.

Establishment of program and project governance and oversight arrangements

3.44 Delivery of the contracted outcomes established in the head contract contributes to the achievement of the Hunter Class Frigate Program and Defence capability objectives. To support the successful delivery of outcomes, Defence policies and guidance require governance documentation to be established. The ANAO reviewed Defence documentation and found that Defence had established the required capability and program governance and project management arrangements set out in the Defence Capability Manual and CASG policy and guidance. High-level capability and program governance and project management arrangements are outlined in Table 3.1 below.

Table 3.1: Key governance documents and ANAO comments regarding delivery

Source: ANAO analysis of Defence documents.

3.45 The governance, oversight and coordination arrangements for the project, as documented in the conditions of contract and the governance documents described above, include higher-level oversight and coordination arrangements for Defence’s naval shipbuilding activity as a whole¹²⁸, as well as project-specific governance and oversight bodies. Defence records indicate that meetings have occurred at the expected cadence and have been attended by the nominated Defence senior leaders. Governance arrangements have also been established in alignment with capability and CASG project management policy requirements.

Establishment of project and program monitoring arrangements

3.46 Project and program monitoring and reporting arrangements inform decision-makers of areas of risk to schedule, capability and budget. Defence has introduced the following arrangements.

• Established monthly project performance monitoring and reporting, on the Project Performance Review Information Platform (PPRIP)¹²⁹, which is collated into reports provided to senior internal and external stakeholders.
• Established formal regular meetings with international governments and navies to inform itself of relevant developments overseas.¹³⁰
• Conducted four Independent Assurance Reviews (IARs) to inform senior Defence officials as to whether projects are on track to deliver approved objectives and ready to progress to the next stage of activity.

Project monitoring and reporting – Project Performance Review Information Platform (PPRIP)

3.47 The ANAO examined 29 monthly PPRIP reports from the commencement of reporting in August 2020 to 31 March 2023.¹³¹ As of March 2023, six of the 11 performance measures were rated ‘red’. These were: cost, risk, schedule milestone performance, scope, contract earned value management and achievements and concerns.¹³²

Meetings with international governments and navies

3.48 The Australian Government has established memoranda of understanding (MOU) with the governments of the United Kingdom and Canada relevant to the Hunter class project, which include forums for the exchange of information.¹³³ Key international forums include:

• Australia-UK Ministerial consultations;
• a National Armaments Directors Forum, co-chaired by Australia’s Deputy Secretary National Naval Shipbuilding and their UK counterpart;
• a Global Combat Ships User Group, co-chaired by Australia’s Director-General Hunter Class Frigates and their UK and Canadian counterparts; and
• a steering committee for the MOU with the UK, co-chaired by Australia’s FAS Major Surface Combatants and Combat Systems and their UK counterpart.¹³⁴

Independent Assurance Reviews

3.49 As of 31 March 2023, four IARs (May 2019, August 2020, May 2021 and February 2022) for the Hunter class frigate program had been conducted since the execution of the head contract.¹³⁵ The IARs have included the following recurring themes.

• Immaturity of key project artefacts, including the Integrated Master Schedule and BAESMA’s Contract Master Schedule, and the performance management baselines.¹³⁶ This has limited the completeness and reliability of progress and performance information.
• Lack of clarity in relation to specific performance measures and tracking and assessing success, particularly in relation to Australian Industry Capability (AIC) and Continuous Naval Shipbuilding (CNS) and how sovereign capability will be achieved.
• Risks posed by Hunter class project delays to the ANZAC transitional arrangements.
• Insufficient resources, in particular skills and expertise in the project team.
• Increased attention needed to manage realised risks, including increased oversight at the two- and three-star level governance forums.
• Challenges to design separation and production commencement due to weight growth, power and cooling margins, and the Type 26 design not reaching the anticipated level of maturity, contributing to delays to key milestones.¹³⁷

3.50 The most recent (February 2022) IAR report, which was finalised in May 2022, noted that the project met the criteria to be listed as a project of concern and recommended that Defence consider elevating it to the projects of concern list.¹³⁸ In September 2022 the Minister for Defence Industry noted that Defence did not recommend adding the project to the projects of concern list at that time, in the context of the review of the project by the Surface Ships Advisory Committee.

Other reviews

3.51 More generally, the Surface Ships Advisory Committee (SSAC) was asked to review aspects of the project and provide input to the Australian Government’s Defence Strategic Review (DSR).¹³⁹ Defence advised the Parliament in February 2023 that the scope of the SSAC’s review was to look at the cost, schedule and risk across the Hunter class program, and that the review and its findings were shared with the DSR. Defence further advised that the review had not resulted in any changes in scope to the project.¹⁴⁰ These reviews are discussed below.

Has Defence’s expenditure to date been effective in delivering on project milestones?

3.52 This section examines: whether the Hunter class program is meeting milestones for schedule, cost and delivery of the required capability; and the program’s alignment with the government’s continuous naval shipbuilding plan and enterprise.

Expenditure under SEA 5000 Phase 1

Total expenditure

3.53 Total project expenditure as of 31 January 2023 was approximately $2.2 billion. As outlined in Table 3.2, the majority of program expenditure (approximately $1.3 billion or 59 per cent) comprised payments to BAESMA under the head contract (design and productionisation scope only), as of 31 January 2023. Payments to other contractors represented 22 per cent of expenditure.

Table 3.2: Expenditure under SEA 5000 Phase 1 to contractors, as of 31 January 2023^a

Note a: Total expenditure represents project accrual position as of 31 January 2023. Vendor categories other than ‘Not Assigned’ represent cash expenditure. ‘Not Assigned’ includes accruals against the project, as well as costs including travel, overseas post costs, and Defence purchasing card costs.

Note b: Payments to named vendors other than BAE primarily relate to: participant services contracts; Advance Work Arrangements; and contracts for the Analysis of Alternatives report and the competitive evaluation process with Fincantieri and Navantia).

Note c: Navantia includes Navantia Australia, Navantia S A and Navantia SA SME.

Note d: RAND Corporation includes both RAND Corporation and RAND Corporation (Australia).

Note e: Totals for percentages and values do not add up due to rounding.

Source: ANAO analysis of data from the Defence ROMAN finance system.

Actual vs planned expenditure

3.54 ANAO analysis of Defence data identified an underspend of $134.7 million against the management services (MSE) scope compared to the phased pricing set out in the head contract from execution to 30 June 2022. There was also an underspend of $328.1 million against the design and productionisation (D&P) scope compared to the phased pricing set out in the head contract from execution to 30 June 2022. The underspend was consistent with Defence’s analysis of BAESMA’s Earned Value Performance Reports, which indicated that BAESMA was behind schedule between work accomplished (earned value) and work planned (planned value) by $93.33 million as at January 2023.

3.55 Defence advised the ANAO in April 2023 that: contributing factors for the underspend against the MSE scope included BAESMA not achieving planned resourcing levels; and contributing factors for the underspend against the D&P scope included delayed achievement of the System Definition Review (see paragraphs 3.76 to 3.82) and BAESMA not achieving planned contract execution for Long Lead Time Item contracts.

3.56 Figure 3.1 shows phased contract pricing and actual expenditure to 31 January 2023.

Figure 3.1: Head contract, actual expenditure vs phased pricing by financial year, to 31 January 2023

Note: Phased pricing for 2022–23 reflects the phased contract price for the whole financial year.

Source: ANAO analysis of Defence documentation and data.

3.57 In January 2023, the Director-General Hunter Class Frigates advised the First Assistant Secretary Major Surface Combatants and Combat Systems, and the Head Navy Capability, that the design and productionisation phase was forecast to be completed within the out-turned second pass approval amount.¹⁴¹

Payment and cost assurance

3.58 The head contract price consists of two components — management services, and design and productionisation scope — which are invoiced monthly in arrears.¹⁴² Monthly and biannual allowable costs reviews are provided for under the contract.

3.59 To guide the conduct of the monthly and biannual allowable costs reviews, Defence undertakes risk planning against an assurance framework and develops a plan for each allowable cost review, including regular and emerging risks to be tested. The process applied by Defence in undertaking the biannual reviews has included validating actual costs against monthly invoice data, controls testing and sample-based transaction testing.

3.60 The ANAO examined six biannual costs reviews conducted to 30 June 2022.¹⁴³Defence documented review outcomes, including instances where BAESMA had invoiced disallowable costs.¹⁴⁴ The reports indicated that Defence had reviewed adjustments required from the prior review period, to ensure these had been credited on the next monthly invoice by BAESMA, and documented that the required adjustments had been actioned by BAESMA.

Delivery of planned design and productionisation milestones

3.61 The ANAO examined all key milestones due under the head contract as of 31 March 2023, to assess the timeliness of key milestone delivery and determine the value of key milestone payments to date (see Appendix 3, which includes milestone descriptions).

Key milestones

3.62 At 31 March 2023, 21 key milestones were due under the head contract. Of these 21 milestones, all had been approved and an additional milestone had been approved which was not yet due.¹⁴⁵ Of the 22 approved milestones, 11 were delivered by the due date and 11 were delivered between two and 505 days late, including five that were delivered more than 100 days late. The achieved key milestones have been delivered, on average, 64 days late.

3.63 The ANAO also examined changes to key milestone dates as a result of Contract Change Proposals (CCPs). On 29 June 2022 Defence signed a CCP which: delayed the due dates for all remaining major design and productionisation milestones that are key milestones; reassigned Key Milestone 18 to the Preliminary Design Review, which gave it a due date and attached payment to its achievement; added an additional Support System Critical Design Review key milestone; and redistributed remaining Scope Fee equally between key milestones on a financial year basis.¹⁴⁶

3.64 As of 31 March 2023, there was schedule slippage for remaining major design and productionisation milestones that were key milestones, with slippage from originally contracted due dates ranging between 17 and at least 31 months (see Appendix 3 of this audit report).

3.65 The ANAO reviewed key milestone acceptance certificates, associated correspondence and invoices for key milestones due as of 31 March 2023. Defence records indicated that Defence had approved five key milestones for payment — worth $22.3 million (18.5 per cent of total key milestone payments) — without all exit criteria being met. Defence’s advice to BAESMA notifying approval of one of these milestones noted that:

The Commonwealth remains fully committed to the principles of Team Hunter and the collaborative ways of working that will underpin our relationship in delivering the scope of the Contract. Notwithstanding, the award of this KM [key milestone] without having fully met all Criteria should not be interpreted as a precedent for this approach being seen as normal practice. Going forward, with future KM payments being subject to fee moderation for late achievement, it is essential that BAESMA deliver outcomes that meet all KM Criteria in full before submitting a Progress Certificate for payment.

3.66 The status of seven key milestones pertaining to delivery of the contract master schedule and significant reviews points during the design and production phase are discussed below.

Contract Master Schedule

3.67 The head contract requires BAESMA to develop and deliver a Contract Master Schedule. The Schedule establishes the performance measurement baseline and is to be used as the primary schedule for managing the contract. The schedule was to be delivered within 20 days of the Integrated Baseline Review 1 (IBR 1) milestone, which was determined by Defence to have been met on 2 March 2022.

3.68 Approval of the Contract Master Schedule and an update were exit criteria for Key Milestones 9 and 13 respectively. As of 22 March 2023, Defence had not approved a Contract Master Schedule (12 months after IBR 1 was met).¹⁴⁷ Nonetheless, Defence advised BAESMA that the intent of these milestones was sufficiently met to pay the $12.1 million attached to the milestones¹⁴⁸, and payment was agreed to on 14 August 2022. The Defence brief prepared for the Director-General Hunter Class Frigates, seeking agreement to pay against Key Milestones 9 and 13, noted as part of the rationale for payment that:

Further delays to BAESMA’s ability to claim these overdue Fee Payments due to these two Data Items is causing a financial impact that is now disproportionate to the impact to the Project Objectives, and is not consistent with the spirit of the ‘Team Hunter’ collaborative relationship that we are working hard to develop.¹⁴⁹

Integrated Baseline Review 1

3.69 The exit criteria for Key Milestone 4 – Integrated Baseline Review 1 (IBR 1) included Defence approval of: any mandated system review action plan to address risks and issues identified during IBR 1; and Major Corrective Action Requests (CARs) being closed or downgraded to ‘Minor’ status.

3.70 On 13 August 2020, Defence approved the IBR 1 Corrective Action Plan (that had been submitted by ASC Shipbuilding), which set out 119 ‘Major’ CARs.

3.71 On 29 September 2020 Defence approved payment of the IBR 1 key milestone prior to the closure of all Major CARs or their downgrade to Minor status, and before formal exit from IBR 1.

3.72 The decision brief for the delegate (First Assistant Secretary, Ships) noted that:

These CARS [Corrective Action Requests] … act to strengthen and provide a solid project management foundation within ASC Shipbuilding.

… While significant progress has been made to date, CAR closure is taking longer than anticipated and is unlikely to meet the targets set in the agreed CAP [Corrective Action Plan]. However, based on progress to date, and subject to ASC Shipbuilding agreement to additional controls and measures … it is recommended that ASC Shipbuilding be paid Key Milestone KM-004.

… Payment of KM-004 will promote goodwill between the CoA [Commonwealth of Australia] and ASC Shipbuilding while working together towards the MAA [Materiel Acquisition Agreement] cardinal milestones. It also demonstrates the CoA’s trust in ASC Shipbuilding’s ability to prioritise and manage this important activity to its conclusion.

The Project does not expect the withholding of payment under KM-004 until all Major CARs have been closed (or downgraded to Minor) will drive better performance from ASC Shipbuilding over the months ahead. Rather, by paying KM-004 now, the CoA believes performance will be enhanced by strengthening the relationship and confirming the CoA’s trust in ASC Shipbuilding’s ability and commitment to improve the PMB [performance measurement baseline].

3.73 In agreeing to the payment of Key Milestone 4, the delegate noted: that the project and BAESMA would continue to track CAR closure against the IBR 1 Corrective Action Plan on a weekly basis; and that closure of the IBR 1 Major and Minor CARs would form an entry criterion to Integrated Baseline Review 2, then planned for 2021.

3.74 On 27 October 2020 Defence advised BAESMA that sufficient progress had been made in closing Major CARs to support the IBR 1 key milestone payment, valued at $2.8 million (GST exclusive). At that time IBR 1 was ongoing and it was expected that formal exit would occur in early 2021, with 81 Major CARs remaining open.

3.75 On 2 March 2022, 491 days after payment was approved, Defence advised BAESMA that it was satisfied that all Major CARs had been closed and IBR 1 had concluded. Defence also advised BAESMA that it had reviewed all IBR 1 entry and exit criteria and was satisfied that the criteria had been met or were not applicable.

Systems Definition Review and Integrated Baseline Review 2

3.76 At execution, the head contract included Key Milestone 7, encompassing the closure of the Systems Definition Review and Integrated Baseline Review 2, with a due date of 20 November 2020.

3.77 The February 2022 Independent Assurance Review (IAR) noted that the Systems Definition Review was being undertaken progressively, with key exit requirements (Land Based Test Site and Mission System Systems Definition Reviews closure) occurring in November 2021, with 11 Major and 37 Minor open actions. The remaining key exit requirement for the Systems Definition Review, the Support System Systems Definition Review (SS SDR), was reported to be delayed to mid-2022 at the earliest.

3.78 On 16 May 2022 Defence signed a CCP splitting Key Milestone 7 into three new key milestones — these were Key Milestones 25–27¹⁵⁰ (see Appendix 3 of this audit report).

3.79 On 23 December 2022 Defence advised BAESMA that ‘the Commonwealth confirms that BAESMA has achieved KM-026’. Defence’s letter to BAESMA also stated that:

In signing the KM-026 Progress Certificate, the Commonwealth is acutely aware that a case could be made to not award the KM [key milestone] based on the Criterion that states: Commonwealth has given notice that it is satisfied that the MSR [Mandated System Review] indicates that sufficient technical progress has been achieved. Noting the views of the SS SDR [Support System Systems Definition Review] Co-Chairs … it could be argued that ‘sufficient technical progress’ has not been achieved and hence the Criterion has been not met. The counter-argument, which is the basis for the Commonwealth’s decision to award the KM, is that that no other Defence maritime project has ever attempted to do what BAESMA and the Commonwealth have embarked upon (in designing an enterprise-wide Support System for the HCF [Hunter class frigate] capability) and as such Team Hunter is setting a standard that hasn’t been attempted and/or achieved by Defence in the past. The Commonwealth believes that this fact hasn’t been taken into account by the Co-Chairs who have made their assessment within a paradigm of a more conventional approach. The Commonwealth is satisfied that sufficient technical progress has been achieved, taking the following into consideration:

a. the ambitious nature of the scope of the SS SDR and associated artefacts;

b. the imperative to continue building a long-term collaborative relationship that enables the naval shipbuilding enterprise to grow Integrated Logistics Support (ILS) and Logistics Engineering capability and capacity in Australia;

c. the effort undertaken by both BAESMA and the Commonwealth to achieve an outcome as close as possible to that contemplated when the Head Contract was negotiated in December 2018, and the subsequent ILS [Integrated Logistics Support] CCP executed in February 2021; and

d. the establishment of a HCF Support System Steering Board … which will oversee the Team Hunter ILS program, thus ensuring there is a realistic and achievable plan for upcoming Support System focused MSRs leading into the Support System Critical Design Review (SS CDR) in 2027.

3.80 The Hunter Class Frigate Program Support System Systems Definition Review (HCFP SS SDR) Design Review Certificate documented the assessment of the review’s BAESMA and Commonwealth co-chairs. It stated that:

On completion of SS SDR the Co-Chairs concluded that much of what had been expected for SS SDR had not been addressed or was still work in progress … the level of maturity required for SS SDR had not been achieved. Actions were subsequently raised to ensure these areas would be addressed going forward in order to reach the level of maturity required to strike a Functional Baseline. The Co-Chairs recommended proceeding to the next phase, while noting the actions raised were intended to ensure that areas of relative immaturity would be addressed in advance of striking a Functional Baseline.

An unconventional approach had been taken, but this approach was poorly documented and had to be teased out during the review. The joint team did support briefings to assessors and key stakeholders in order to facilitate a better understanding of the approach taken.

The way ahead beyond completion of SS SDR was equally unclear and had to be teased out in briefings and workshops supported by the joint team. Actions were issued to add clarity to the path ahead, and to ensure an appropriate degree to oversight and governance is applied going forward.

3.81 A Systems Definition Review Harmonisation Event was held on 17 November 2022 to align and confirm coherence between the ‘functional baselines’ resulting from the Mission System, Support System and Land Based Test Site Systems Definition Reviews. The Harmonisation Event Certificate stated that all objectives had been adequately addressed.¹⁵¹

3.82 Defence conducted the IBR 2 event between 31 October and 11 November 2022 and finalised a report on the outcomes on 12 December 2022. The report identified 12 Major CARs and 10 Minor CARs. One of the Major CARs was identified as ‘Critical’, with an ‘Overarching need to consolidate and develop the optimum Programme organisation that engenders clarity on roles, responsibilities, direction and integration.’¹⁵² As at 22 March 2023, six Major and nine Minor CARs remained open, of the original 22, and Defence had not approved the Corrective Action Plan due to the two versions submitted by BAESMA not adequately addressing all Major CARs.¹⁵³ As of that date, five of the seven criteria to formally exit IBR 2 were ‘not met’ pending approval of the Corrective Action Plan and closure or downgrading of Major CARs to Minor status. One of the criteria was partially met pending approval of the Contract Work Breakdown Structure, which Defence records indicated was in the final stages of approval.¹⁵⁴

Preliminary Design Review

3.83 The June 2022 Contract Change Proposal had set the due date for the Preliminary Design Review (PDR) milestone for 23 October 2022.

3.84 However, the May 2022 monthly coordination meeting papers reported that the PDR was likely to occur in July 2023 and would be based on a reduced review scope.¹⁵⁵ Details of subsequent reviews pertaining to the remainder of the intended PDR scope were still being developed. The August 2022 Contract Status Report reported that a final PDR checklist was agreed between BAESMA and Defence on 5 September 2022.

Developing project cost estimates

3.85 The Hunter class project is in the design and productionisation stage, which will inform Defence’s planning and contracting for construction and Defence’s final estimate of construction costs.

3.86 Active management of identified risks and issues — including what Defence has described as risks to ‘overall budget affordability’¹⁵⁶ — is essential for program success. Defence reported to Parliament, in the context of the 2020–21 Major Projects Report, that the following risk had been realised and transitioned into an issue: ‘Acquisition of the Hunter Class Frigate may be affected by overall funding or programming issues arising from internal cost growth / forecasting accuracy and external budget constraints, leading to an impact on capability and schedule’.¹⁵⁷ Defence further reported, in the context of the 2021–22 Major Projects Report, that: ‘The acquisition and sustainment of Hunter Class Frigates is not achievable with the allocated funding’.¹⁵⁸ In further advice to Parliament in February 2023, Defence stated that ‘there’s very high risk around the budget for the Hunter class program’.¹⁵⁹

3.87 As of January 2023, Defence’s internal estimate of total acquisition costs, for the project as a whole, was that it was likely to be significantly higher than the $44.3 billion (2018–19 Budget out-turned) advised to government at second pass in June 2018. As of March 2023, the government had not been advised of Defence’s revised acquisition cost estimate, which Defence has been refining in preparation for returning to government for approval of the batch one build scope. Defence advised the ANAO in April 2023 that:

It would be inappropriate to provide Government an updated estimate when a large amount of uncertainty remains in elements of the estimate, including the BAESMA Head Contract element for which a final price will not be received until mid 2023.

3.88 The following sections outline the rising project cost estimates developed by Defence, and internal Defence assessments of the key drivers behind those estimates.

Cost estimates – advice to government since second pass

3.89 In August 2020 Defence advised government that the total acquisition cost estimate was $45.6 billion out-turned (pre-Expenditure Review Committee 2020–21), which reflected the second pass total acquisition cost estimate updated for foreign exchange movements.¹⁶⁰

3.90 In its June 2021 advice to government seeking approval to delay the cut steel date for ship number one by 18 months, Defence noted the risk that the project may exceed its cost envelope (this is discussed further at paragraphs 3.105 to 3.106). In relation to this risk, the advice noted that the delay would allow additional time to address supply chain challenges and drive down procurement costs for the batch one build (comprising three ships).

3.91 Defence advised the government in February 2022 that final batch one¹⁶¹ build scope costs would be provided at the second pass approval stage for batch one, in the third quarter of 2022‍–‍23.¹⁶²

3.92 In October 2022, Defence advised its portfolio Ministers that ‘there are significant pressures on the budget driven by the impact that the COVID-19 pandemic has had on supply chain costs and delays, freight costs and workforce absences. The current [design and productionisation] phase of the contract is not at risk, however, there is extreme pressure on the batch 1 costs with the increases in supply chain and labour costs’.

Cost estimates – internal updates

3.93 Internal advice of January 2023 to the First Assistant Secretary (FAS) Major Surface Combatants and Combat Systems, and the Head Navy Capability, was that the project ‘remains unaffordable within the Integrated Investment Program (IIP) provision’.¹⁶³ That is, while the current design and productionisation stage remains within its approved budget allocation, the total estimated acquisition cost would exceed both approved funding and the unapproved IIP provision.¹⁶⁴

3.94 The First Assistant Secretary’s annotation on this internal advice was that ‘it appeared that BAE underestimated the combat system design, whole ship design and construction even considering the scope adjusted changes.’ Head Navy Capability’s annotation on the advice was that ‘the cost model continues to be updated, however the scale of the cost estimate from Second Pass is so significant, it is no longer about capability trade at the margins. It is fundamentally now a discussion about increasing the provision held by the IIP through offset of other capability (ie. no new money) or a reduction in the number of vessels to be delivered by the project.’

Internal reviews – observations on project costs

3.95 The February 2022 Independent Assurance Review (IAR) also reported a very high risk that the nine ship build will ‘not be affordable within the current IIP provision’ and that:

Even if the enhanced prototype blocks are used in the Batch 1 build as planned, the schedule extension inherent in the Interim Arrangement will introduce increased costs. Also, supply chain costs have increased significantly. There is a strong likelihood that Batch 1 will consume a significantly higher proportion of the overall IIP provision than previously anticipated, placing financial pressure on the nature and scale of re-design/configuration changes that can be undertaken or are affordable in Batches 2 and 3.¹⁶⁵

3.96 Further, the February 2022 IAR reported that:

the UK design and build has not yet provided a firm basis upon which to finalise the HCF [Hunter class frigate] design or to derive reliable estimates of the likely HCF schedule and cost.

3.97 A Surface Ships Advisory Committee (SSAC) Report dated 24 April 2022 reported that:

lack of design maturity means that cost and schedule uncertainty is still very high … This high uncertainty will almost certainly be reflected in the BAESMA Cost Model that will be submitted for Build Scope 1, thus challenging affordability.¹⁶⁶

Defence’s management of other key risks and issues to delivery

3.98 In addition to the affordability risks discussed in the previous section, a number of key project risks and issues have emerged or have been identified as requiring active management. These include: slower than expected design maturity progress; the impact of COVID-19 on schedule and cost; workforce issues; the vessels’ capability to counter threats; and design challenges relating to weight growth, power and cooling margins. Defence’s public reporting on the project’s major risks, issues and remedial actions — released in the context of the Defence Major Projects Report (MPR) for 2021–22 — is reproduced in Appendix 5 of this audit report.

3.99 The following section examines the impacts on the project of design immaturity, COVID-19 and some workforce issues. The ANAO has not reviewed the detailed design, engineering and construction issues — such as those relating to ship weight, power and cooling¹⁶⁷, construction drumbeat¹⁶⁸, and military capability¹⁶⁹ — which are being worked through as part of the design process and construction planning.

Internal reviews – observations on design maturity

3.100 The February 2022 Independent Assurance Review (IAR) reported that:

The Type 26 was not a mature Reference Ship Design (RSD), has matured much more slowly than anticipated and some critical design aspects are still to be resolved; a number of key performance parameters have not yet been met …

…

The COVID pandemic has impacted significantly (in both schedule and cost) on the development of the UK and Australian designs and the supply chain for major equipment and sub-systems, and on the availability and mobility of key personnel to participate in project events and reviews.

3.101 In its January 2023 report the Surface Ships Advisory Committee (SSAC) stated that:

When Government selected the BAE Systems Type 26 as the Reference Ship Design in 2018, it was clearly understood that they were selecting an approach that was highest in risk (compared to the baseline versions of the other two competing options) with respect to design maturity (whilst also highest in potential for capability/performance). The Type 26 was yet to be fully designed, built and tested. Because of this, cost growth was anticipated and was reflected in risk and uncertainty provisions in the cost model that was used for the Acquisition Cost Estimate provided at Second Pass, however, 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.

3.102 Further, the SSAC observed that:

BAESMA is behind schedule on the HCF [Hunter class frigate] design for several different reasons – one of which is limited design resources. HCF design is being undertaken mostly in the UK by BAESMA’s parent company (BAE Systems Naval Ships), and partly in Australia. More design and engineering resources are already needed in both locations and at the same time, attrition rates (currently 15% in the UK and 12% in Australia as advised by BAESMA) are higher than normal. Accordingly, there is no reason to believe at present that the remaining design work will progress at a faster rate than is currently being achieved thus putting design and production schedules at further risk.

3.103 The Contract Status Report for the February 2023 reporting period indicated that BAESMA was 89 per cent resourced to plan, with key resourcing gaps including 16 FTE (full-time equivalent personnel) for ‘Platform – Detailed Design’.

Impacts of design immaturity

3.104 Design immaturity has affected Defence’s planning for the construction phase, led to an extension of the design and productionisation phase, and diverted approved government funding for long lead time items to pay for the extension and other remediation activities.

3.105 To progress the build of the Hunter class frigates, on 7 July 2020 Defence issued BAESMA with a scope notice for the batch one (three ships) build scope, to which BAESMA responded on 31 May 2021.¹⁷⁰ Defence’s assessment of BAESMA’s response indicated ‘extreme’ risk for Defence to achieving a contractable batch one build scope offer from BAESMA, due to: ‘immaturity across all submitted artefacts and Contract Deliverables’; and BAESMA adopting ‘a much lower risk appetite than the Commonwealth expected of its long term strategic partner.’

3.106 In June 2021 the Australian Government agreed to extend the design and productionisation period, and to an 18-month delay to the cut steel date for ship one, to enable Defence and BAESMA to improve design maturity and develop a contractable offer for the batch one build scope. This is called the ‘Interim Arrangement’.¹⁷¹ The government’s decision was based on Defence advice that the commencement of Type 26 construction in the UK was based on low design maturity, creating a design backlog. Defence further advised government that COVID had exacerbated the design backlog, and that it was not until late 2020 that the actual state of the UK Type 26 design was communicated to Australia following a change in senior leadership at BAE Systems.¹⁷²

3.107 While agreeing to an 18-month delay, the Australian Government also required Defence to explore the following two options and provide further advice on these in mid-2022.

• Undertaking additional enhanced (Hunter class) prototyping activities at the Osborne (South Australia) shipyard.¹⁷³ This would involve the prototyping of ship one blocks only, with the removal of ship two blocks from the build sequence.
• Producing Type 26 blocks in Australia for export into the UK’s Type 26 program.

3.108 In December 2021 Defence advised the Australian Government that the opportunity to export blocks into the UK’s Type 26 program as part of extended prototyping had been explored, but was assessed as not viable, as it would increase schedule risk. Defence further advised that it considered that BAESMA would recover the schedule delay over the life of the project and deliver the final ship as planned in 2044.¹⁷⁴

3.109 The February 2022 Independent Assurance Review (IAR) subsequently noted that there was ‘not yet sufficient information or evidence to provide confidence that the ship delivery schedule can be recovered by Batch 3.’ The IAR further noted that:

The extension of the D&P [design and productionisation] period was justified in part on the basis of an expected ability subsequently to reduce the ship build period. However, there is not presently any credible basis for planning a reduced ship build period (below 7.5 years) or for anticipating a capacity to achieve efficiencies/reductions in the subsequent ship builds — noting that the Australian build involves uncertainty about a range of new work (e.g. the build of the complex mast structure) and associated schedule/cost risk and the level of automation is likely to be less than anticipated with a higher level of manual welding and handling.

3.110 In February 2022, the Australian Government agreed to re-purpose $590.4 million (MYEFO 2021–22 out-turned) of the long lead time item funding approved at second pass, to fund: four additional prototyping blocks to be used in Batch 1; and continuation of BAESMA management services and related head contract activities from July 2022 to June 2024.¹⁷⁵ The government also agreed to re-purpose $189.4 million of the approved long lead time item funding for continuation of Defence project management activities from July 2022 to December 2024. Defence’s advice to government noted that the proposal to re-purpose approved funding included $8.9 million for Hunter class frigate future batch development and design studies, as set out in the Surface Combatant Capability Transition Plan.

3.111 Defence advised the ANAO in April 2023 that:

The re-purposing of funds from Long Lead Time Items (LLTI) to the Interim Arrangement has not impacted the establishment of the BAESMA Supply Chain. … BAESMA was experiencing delays with establishment of the Supply Chain when the Interim Arrangement was initially considered.

In June 2022 a Supply Chain Steering Board was established. Co-chaired by senior executives from both BAESMA and Defence (BAE Acquisition Director and DG [Director-General] Hunter Class Frigate), the Steering Board meets weekly to review the performance of the combined Supply Chain team in establishing the 60 Long Lead Time Item (LLTI) contracts required for Batch 1.

Since the establishment of the Steering Board, the number of contracts executed by BAESMA for LLTI items has increased from 10 (which had taken three years to contract) to 22 (as at 20 Mar 23). The current forecast is 56 LLTI contracts executed by December 2023.

3.112 A (PGPA Act) section 23 commitment approval to the value of $529.1 million (GST inclusive and escalated to Budget 2022–23 out-turned) was signed by the Director–General Hunter Class Frigates on 1 June 2022. The relevant Contract Change Proposal (CCP) was executed on the same day. The CCP increased the contract price by $422.8 million (GST exclusive) and incorporated the following objectives critical to schedule: ‘the VAD [vessel acceptance date] for ship one is no later than December 2031’ and ‘the VAD for Ship 9 is no later than 2044.’¹⁷⁶

3.113 Defence advised the ANAO in April 2023 that it expected the $422.8 million would be offset from the price of the planned batch one build scope.¹⁷⁷

3.114 Of this $422.8 million, $265.1 million was allocated to the management services scope of the head contract and $157.8 million was allocated to the design and productionisation scope. As noted in paragraph 3.54, at 30 June 2022 there was an underspend against phased contract pricing of $134.7 million for the management services scope, and an underspend of $328.1 million for the design and productionisation scope.

3.115 The CCP for the ‘Interim Arrangement’ also added Interim Arrangement key milestones, to which payment of Scope Fee for the relevant period was attached.

3.116 The February 2022 Independent Assurance Review questioned the appropriateness of attaching Scope Fee to the Interim Arrangement milestones:

The rationale for profit on the extended management services in the Interim Arrangement should also be reviewed. It is inappropriate to pay profit on rework or on costs arising from schedule delay due to inadequate program execution on the part of BAESMA. The arrangements must ensure the long term partnership does not allow BAESMA to enshrine inefficient practices and unjustified management overheads in the absence of competition.¹⁷⁸

3.117 In its January 2023 report, the Surface Ships Advisory Committee (SSAC) made a number of observations on planning for the delivery of ship one in 2031.

As of the time of this review, BAESMA has a deterministic (i.e., not risk adjusted) schedule showing Ship 1 delivery in early 2031. BAESMA advises that when constraints are removed and a schedule risk assessment is made at P70 level [70 per cent probability], 16 months are added (moving delivery to mid 2032).

…

BAESMA is looking at ways to improve the schedule and a key objective in driving to achieve a 2031 delivery is to increase productivity such that they build a unit (portion of a ship block) at the rate of one every 10 days. … On the initial Prototype blocks, they were achieving a rate of about 25 days per unit. … when the SSAC asked how they expect to get it down to 10 days per unit (especially on a first of class vessel), the response was that they are looking at the likely need for a full second shift during production of ships 1 and 2.¹⁷⁹

Assessing and managing the impact of changes to the Hunter class delivery schedule on existing capability

3.118 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. This section reviews issues arising from the delayed Hunter class delivery schedule and actions taken to assess and manage capability issues.

3.119 Defence advised the Senate Foreign Affairs, Defence and Trade Legislation Committee, at Budget Estimates hearings in April 2022, that it had undertaken studies confirming the viability of the ANZAC class into the 2040s and beyond, with no prohibition on the ANZAC class being extended further than planned.¹⁸⁰

3.120 Other options to manage capability are also being considered, including unsolicited proposals. For example, on 9 November 2022 Defence informed the Senate Foreign Affairs, Defence and Trade Legislation Committee that the government had received an unsolicited proposal from Navantia to build three additional Hobart class destroyers and the response was being considered under the Defence Strategic Review:

We have received an unsolicited proposal from Navantia. In fact, we have received two. They have just recently submitted a second unsolicited proposal to us. They will follow a standard process that we use when we receive unsolicited proposals, and Navantia have told us that they have made similar submissions to the Defence Strategic Review. How the review weighs it is a matter for the review.¹⁸¹

3.121 These two unsolicited proposals were a proposal for the acquisition of three new Hobart class destroyers, received in May 2022, and a subsequent proposal for six corvettes. Defence has engaged the RAND Corporation to undertake a feasibility study for the acquisition of three new Hobart class destroyers.¹⁸²

3.122 Defence records indicate that capability risk for the surface fleet has been drawn to the attention of Defence senior leaders. For example, the February 2022 Independent Assurance Review (IAR) reported that:

There is a Very High risk that the first [Hunter class] ship will not be delivered by the proposed 2031 date; the Board assesses that the risk is almost certain to be realised, and the consequences would be critical, in terms of the implications for the major combatant surface fleet and the transition from the ANZACs.¹⁸³

3.123 The April 2022 Surface Ships Advisory Committee (SSAC) Report noted that:

The SSAC understands that CASG intends to undertake the Transcap [Transitional Capability Assurance Program] CS [Combat System] upgrade on the ANZAC Frigates and the DDG [Hobart class destroyer] CS Upgrade in advance of the integration/testing of the HCF [Hunter class frigate] combat system as a de-risking measure. Whilst the SSAC recognize the potential for this approach to de-risk HCF from a technical perspective, the SSAC are concerned that it may actually increase schedule and cost risk because much of this work will be done with significant schedule overlap.

3.124 The January 2023 Surface Ships Advisory Committee report observed the interaction between the Hunter class project and other naval projects, including workforce transition issues.

The HCFP [Hunter class frigate project] is not happening in isolation and other Defence projects happening in parallel will impact the Resource picture. The first 2 Offshore Patrol Vessels (OPVs) being constructed under the SEA 1180 Project are being constructed at Osborne with a workforce that will transition to the HCFP. Previous planning had that workforce being handed back to BAESMA in March 2023 for work on Prototyping and Schedule Protection Blocks, but OPVs 1 and 2 are behind schedule and that transition is not going to happen as planned, therefore, BAESMA has now been advised that the OPV workforce will be released in December 2023. The Commonwealth intends to carry out the ANZAC Class Frigate Transition Capability Assurance Program (TRANSCAP) in Perth and the Hobart Class Destroyer Upgrade project in Osborne in parallel with HCF design and production. At present, BAESMA does not have the scope of work and schedule for the Hobart Class Destroyer Upgrades so the combined resource demand on BAESMA is not yet known and thus far has not been accounted for in their resource demand planning for HCF engineering and production. … we recommend that Defence Leadership ensure that the Resources needed to cope with that overlap are understood and achievable [emphasis in original].

3.125 The transition from the existing ANZAC class frigate capability is to be managed through Defence’s Surface Combatant Capability Transition Plan. The transition arrangements include upgrades as part of the ANZAC Midlife Capability Assurance Program and Transitional Capability Assurance Program.¹⁸⁴ To support the transition, additional funding (approved under Project SEA 5014-1) will supplement ANZAC class sustainment funding to maintain capability and ensure sufficient margins of space, weight and power to enable upgrades through margin reclamation.¹⁸⁵ On 12 September 2022, government approved $631 million in SEA 5014-1 funding over five years as part of a six monthly Surface Combatant Capability Transition Plan update.

3.126 Hunter class frigate project delays have resulted in changes to the planned withdrawal of ANZAC class frigates and the overall size and composition of the frigate fleet. Defence informed the ANAO in December 2022 that:

the original plan had the first Anzac retiring on the acceptance of the second Hunter, transitioning Navy to a 9-ship frigate force at the beginning, now the first Anzac will be retired on delivery of the first Hunter, transitioning Navy to a 9-ship frigate force at the end of the program.

Government naval shipbuilding objectives

3.127 The 2017 Naval Shipbuilding Plan outlined the Australian Government’s naval shipbuilding objectives as follows:¹⁸⁶

Delivering the Naval Shipbuilding Plan will result in a national approach to the delivery of affordable and achievable naval capability through a sovereign Australian industrial base that is reformed, secure, productive and cost-competitive.

3.128 The Hunter class head contract includes requirements relating to Continuous Naval Shipbuilding (CNS) and Australian Industry Capability (AIC).

3.129 The contracted requirements are reflected in BAESMA’s CNS Strategy and Plan.¹⁸⁷ Other key documents addressing CNS and AIC include the Sovereign Capability and Option Deed (SCOD)¹⁸⁸, Workforce Management Plan, and Supply Chain Management Plan.

3.130 The CNS Strategy was initially approved on 25 October 2019 and incorporated into the head contract through a Contract Change Proposal on 22 November 2019.¹⁸⁹ Under the CNS Strategy it is envisioned that there will be a separate CNS Plan for each scope, along with separate Workforce Management and AIC Plans. The CNS Strategy states that at the completion of each scope, overall performance of the CNS Strategy will be evaluated.¹⁹⁰

3.131 At contract execution, the head contract included a draft CNS Plan, draft AIC Strategy and draft AIC Plan. The CNS Plan was approved on 7 May 2020 and incorporated into the head contract on 2 July 2020.¹⁹¹ The CNS Plan is largely structured around the four key enablers identified in the 2017 Naval Shipbuilding Plan.¹⁹²

3.132 The AIC Strategy outlined an Australian contract expenditure target of 58 per cent of total contract value and 54 per cent for the design and productionisation phase.¹⁹³ The draft AIC Plan outlined, in more detail than the AIC Strategy, ASC Shipbuilding’s approach to maximising opportunities for Australian industry participation, and AIC management, monitoring and reporting arrangements.¹⁹⁴ The AIC Plan was first approved on 24 October 2019.¹⁹⁵

3.133 Government has agreed to a proportion of approved project funding to be used to invest in Australian industry, on a case-by-case basis, to lift the level of Australian industry participation above the contracted level of AIC over the life of the project. Funding of $600 million has been set aside for AIC purposes and is excluded from the contract price. The release of this funding to BAESMA is subject to a business case development and approval process outlined in the AIC Strategy and Plan, and the approval of a Contract Change Proposal.¹⁹⁶

3.134 Achievement of the government’s naval shipbuilding objectives is being measured through the Continuous Naval Shipbuilding (CNS) Capability Maturity Assessment Framework contained in the CNS Strategy and Plan and through the Strategic Performance Measures under the head contract. Contract Status Reports include a graphical representation of CNS maturity assessed against the CNS Capability Maturity Assessment Framework and exception based narrative reporting.¹⁹⁷

3.135 BAESMA’s February 2023 assessment of CNS maturity, compared to the baseline established at the commencement of the design and productionisation phase, is that there had been an improvement in CNS maturity over the life of the project, with five of the six capabilities assessed as improving from ‘Limited’ to ‘Reliant’. CNS maturity, as assessed by BAESMA against the CNS maturity framework for the February 2023 CSR reporting period, is shown in Figure 3.2.

Figure 3.2: Continuous Naval Shipbuilding (CNS) capability maturity assessment as at February 2023 contract status report (CSR) reporting period

Source: Defence documentation.

3.136 As of March 2023, the two following CNS ‘medium’ level risks were recorded in Defence’s CapabilityOne system.

• ‘The level of capability contribution achieved to build a sovereign CNS industry does not meet expectations’.
• ‘There is a chance that BAESMA and the T26 OEMs [Type 26 frigate original equipment manufacturers] do not maximise opportunities for Australian Industry participation in each batch and achieve sovereign shipbuilding capability for Australia’.

3.137 The Australian Government’s 2017 Naval Shipbuilding Plan identified four ‘key enablers’ for the naval shipbuilding enterprise, one of which was: ‘a motivated, innovative, cost-competitive and sustainable Australian industrial base, underpinned initially by experienced international ship designers and builders who transfer these attributes to Australian industry’ [emphasis in original].¹⁹⁸ The February 2022 Independent Assurance Review (IAR) commented that:

The [IAR] Board was not assured that there is a clear path to, or any basis for confidence about, the Australian ship design capability planned to be available by Batch 3 to support the design of the next generation surface combatant, with delays already in the transfer to and development in Australia of the personnel and skills.

3.138 The January 2023 Surface Ships Advisory Committee (SSAC) report concluded as follows:

the SSAC considers that the HCFP [Hunter class frigate program] is a viable, yet still High Risk program that is the foundation for Continuous Naval Shipbuilding in Australia and thus our recommendation to ‘stay the course’. The HCFP Enterprise participants are committed to working collaboratively through the “Team Hunter” approach and whilst continuing efforts on effective collaboration are required, the SSAC have seen good indications that this “Team Hunter” approach is taking hold across the Enterprise. The SSAC have endeavoured to identify what we believe are the current key risks and issues and have provided 15 recommendations in this report to help address them. Some of those recommendations have been raised previously by the SSAC and/or in other independent reviews in one form or another and we believe that they comprise the priorities for Defence Leadership [emphasis in original].

3.139 Defence advised the ANAO in April 2023 that shipbuilding capability risks would be managed through the Sovereign Capability and Option Deed (the SCOD, discussed in paragraph 3.129 and footnote 188 of this audit report) via a Sovereign Capability Implementation Plan required for the acceptance of ship one. The SCOD requires that the plan be updated and resubmitted at least 20 working days prior to acceptance of each subsequent ship. Defence further advised that obligations under the SCOD were being managed by a Naval Shipbuilding and Sustainment Enterprise Headquarters with responsibility for implementing the 2017 Naval Shipbuilding Plan¹⁹⁹:

More broadly for the naval shipbuilding and sustainment enterprise, shipbuilding capability risk is being addressed through a multi-pronged approach aimed at developing and promoting sovereign growth throughout the supply chain. This includes the development of [a] Naval Shipbuilding and Sustainment Enterprise Strategy framework which seeks to assist Government and industry to prioritise investments in critical sovereign industry capability.

3.140 The public version of the Defence Strategic Review commissioned by the government, which was released on 24 April 2023, made the following recommendation on naval shipbuilding:

The Government should confirm its commitment to continuous naval shipbuilding through an updated National Naval Shipbuilding Enterprise Strategy and updated supporting Naval Shipbuilding and Sustainment Plan.²⁰⁰

3.141 Government agreed to the recommendation.²⁰¹

Summary

3.142 In summary, as at February 2023 Defence faced the challenge of managing risks and issues in the Hunter class frigates project on a wide front. Defence has reported to the Parliament that:

The Project is currently managing risks and issues at both a strategic and tactical level. Strategic risks and issues … broadly fall under a number of key areas being:

• Ship design maturity;
• System Integration;
• Operating Capability delivered to Navy;
• Industry and Navy workforce;
• Australian Industry Capability; and
• Overall budget affordability.²⁰²

3.143 As identified by internal Defence reviews, including Independent Assurance Reviews and reports of the Surface Ships Advisory Committee, active Defence leadership and contract management are essential to address identified risks and issues and for the successful delivery of the project. The effective management of consequential and related risks — for other naval shipbuilding and sustainment projects, and for Navy capability — is equally essential for the delivery of the Australian Government’s naval shipbuilding policy and national security objectives as understood when the project commenced.

3.144 Defence advised the Parliament on 15 February 2023 that the Hunter class ‘is also one of those capabilities that have been and are being reviewed by the Australian government’ in the context of the Defence Strategic Review commissioned by the government.²⁰³ The final report of the reviewers was handed to the Prime Minister and Minister for Defence on 14 February 2023. The Prime Minister stated that the review would help ‘ensure Defence’s capability and structure is fit for purpose and delivers the greatest return on investment.’²⁰⁴ As noted in paragraph 3.140, a public version of the review was released on 24 April 2023²⁰⁵, which included the following recommendations:

• An independent analysis of Navy’s surface combatant fleet capability should be conducted in Q3 2023 to ensure its size, structure and composition complement the capabilities provided by the forthcoming conventionally–armed, nuclear-powered submarines. The analysis must assess: the capability requirements to meet our current strategic circumstances as outlined in the Review, as well as the cost, schedule, risks and the continuous shipbuilding potential of each option.
• The acquisition of a conventionally–armed, nuclear-powered submarine capability in the shortest possible timeframe should be prioritised as part of AUKUS Pillar I.²⁰⁶

3.145 The Australian Government has agreed to these recommendations and the proposed timeframe, with the final report of the independent analysis team to be provided to government in Quarter 3 2023.²⁰⁷ The independent analysis is to be undertaken by a former United States Navy Vice Admiral, a former Secretary of the Department of Finance, and a retired Royal Australian Navy Vice-Admiral.²⁰⁸

Appendix 1 Entity responses

ANAO comments on Department of Defence response

1. As outlined in paragraphs 2.7 to 2.15 of the audit report, shortcomings in Defence record-keeping are discussed throughout the report. In the context of the competitive evaluation process, Defence did not retain complete records of the key decisions made during the shortlisting process for the evaluation activity, including: the basis for the Ship Building Steering Group’s decision to approve seven ship designs for further analysis and the rationale for the Defence Secretary’s (the decision maker’s) selection of the BAE Type 26 over the French FREMM (DCNS) as the third option. In the context of Defence’s development of advice for second pass government approval, the minutes of the relevant Defence Committee meeting were not retained and it is unclear what deliberations took place. The hand-written notes provided to the ANAO as evidence did not include references to the relative value for money of the tenders (discussed in paragraphs 2.64 to 2.66).
2. As outlined in paragraphs 2.53 to 2.102, Defence’s advice to government at second pass on the selection of the preferred ship design did not include an assessment of value for money or include whole-of-life cost estimates as required by the Budget Process Operational Rules applying to Defence.
3. As outlined in paragraphs 2.30 to 2.44, in accordance with the Tender Evaluation Plan, the Source Evaluation Report did not include a value for money assessment and did not recommend a preferred tenderer; and the Source Evaluation Report Supplement did not include a value for money assessment (which had been identified as an objective of the Offer Definition and Improvement Activities) or recommend a preferred tenderer. As discussed in paragraphs 2.32 to 2.35, the approach to tender evaluation adopted by Defence was not consistent with the Commonwealth Procurement Rules (CPRs) or the Defence Procurement Policy Manual 2016, which applied at the time.
4. As outlined in paragraphs 2.86 to 2.102, Defence has conflated an industry policy objective with the achievement of value for money in procurement, as required by the CPRs — in effect arguing that a procurement undertaken to help effect this policy objective will necessarily represent value for money. The effect of paragraph 4.4 of the CPRs is to establish an obligation on officials to assess value for money, which cannot be excluded from a procurement process, as in the 2017 Tender Evaluation Plan for this procurement (discussed in paragraphs 2.31 to 2.35).
5. As outlined in paragraph 3.10, the minute seeking Public Governance, Performance and Accountability Act 2013 section 23 commitment approval for the Hunter class head contract advised the delegate that the achievement of value for money was supported through arrangements in the negotiated head contract, but did not document a formal assessment of value for money.
6. As outlined in paragraph 2.79, the Department of Finance noted that Defence, in providing a sustainment provision in place of a sustainment cost estimate, had not met the requirement in the Budget Process Operational Rules applying to Defence to provide whole-of-life cost estimates.
7. As outlined in paragraphs 2.99 to 2.100, a feature of Defence’s management of this procurement and related advisory processes is that they lacked a value for money focus, and in that sense the procurement did not comply with the core rule of the CPRs.

ANAO comments on Department of Finance response

1. As outlined in paragraphs 2.79 to 2.80 of the audit report, Finance prepared an assessment that was included in draft second pass advice provided by Defence to its ministers. Among other things, Finance drew attention to what it considered to be limitations in Defence’s advice on cost, and noted that the selection of the preferred tenderer was based solely on capability. Finance did not comment on Defence’s approach to the procurement or lack of value for money assessment.

Appendix 2 Improvements observed by the ANAO

1. The existence of independent external audit, and the accompanying potential for scrutiny improves performance. Improvements in administrative and management practices usually occur: in anticipation of ANAO audit activity; during an audit engagement; as interim findings are made; and/or after the audit has been completed and formal findings are communicated.

2. The Joint Committee of Public Accounts and Audit (JCPAA) has encouraged the ANAO to consider ways in which the ANAO could capture and describe some of these impacts. The ANAO’s 2021–22 Corporate Plan states that the ANAO’s annual performance statements will provide a narrative that will consider, amongst other matters, analysis of key improvements made by entities during a performance audit process based on information included in tabled performance audit reports.

3. Performance audits involve close engagement between the ANAO and the audited entity as well as other stakeholders involved in the program or activity being audited. Throughout the audit engagement, the ANAO outlines to the entity the preliminary audit findings, conclusions and potential audit recommendations. This ensures that final recommendations are appropriately targeted and encourages entities to take early remedial action on any identified matters during the course of an audit. Remedial actions entities may take during the audit include:

• strengthening governance arrangements;
• introducing or revising policies, strategies, guidelines or administrative processes; and
• initiating reviews or investigations.

4. In this context, the below actions were observed by the ANAO during the course of the audit. It is not clear whether these actions and/or the timing of these actions were planned in response to proposed or actual audit activity. The ANAO has not sought to obtain assurance over the source of these actions or whether they have been appropriately implemented.

• On 9 August 2022, Defence approved a Contract Management Plan for the Hunter class frigates contract with BAE Systems Maritime Australia, 44 months (3.6 years) after contract execution.

Appendix 3 Hunter class frigate head contract key milestones, at 31 March 2023

Appendix 4 Contracted monitoring and reporting arrangements

Note a: Cumulative Australian contract expenditure as reported in the February 2022 period CSR was $917 million, or 37 per cent of the total design and productionisation value.

Note b: Earned value management measures earned value (budget cost of work performed) against planned value (budgeted cost of work scheduled). BAESMA measures performance using two indicators: schedule performance index (earned value divided by planned value); and cost performance index (earned value divided by actual costs).

Note c: Some of the coordination meetings overlapped with quarterly progress meetings and management reviews. The number of meetings recorded includes instances where these meetings overlapped.

Source: Defence documentation.

Appendix 5 Major risks and issues – public reporting in the 2021–22 Defence Major Projects Report

SEA 5000 Phase 1, Hunter Class Frigate Design and Construction, Major Risks and Issues, extract from Department of Defence Project Data Summary Sheet (PDSS), appearing in Auditor-General Report No. 12 of 2022–23, 2021–22 Major Projects Report, pp. 144–45.

Major Project Risks

Source: Defence PDSS appearing in Auditor-General Report No. 12 2022–23, 2021–22 Major Projects Report, pp. 144–45.

Major project issues

Source: Defence PDSS, appearing in Auditor-General Report No. 12 2022–23, 2021–22 Major Projects Report, pp. 144–45.