Sunday, April 26, 2015

Defence industry policy – why it matters

Why does defence industry policy matter? Why does defence industry itself matter? If it DOES matter (and successive Australian Defence White papers have stated this is the case), then it’s because of what industry can deliver to the Australian Defence Force (ADF).

However, much of Defence’s industry policy focuses on sustainment – the industry’s ability to maintain, repair and upgrade the equipment currently in service with the ADF, or about to enter service.
But there’s no explicit commitment to buying equipment from Australian suppliers, beyond niche requirements for indigenous industry capabilities – the ability to design, build and integrate equipment that can’t or shouldn’t be acquired from overseas.

I’ll deal with the industry policy shortly, but the diagram below helps explain the harsh realities facing both Australia’s defence industry and the Department of Defence.

This diagram maps in simplified form the landscape of Australia’s defence market. The vertical axis represents the number of customers there are for a particular piece of equipment; the horizontal axis represents the complexity of the equipment. The diagram includes a selection of equipment and platforms either in service with the ADF at the time this diagram was drawn, in late-2010, or likely contenders at that time for a future contract.

The Australian defence industry is generally positioned towards the bottom of the graph in the blue ‘Australian Industry’ ellipse. This contains those products developed entirely or mainly in Australia by local firms with the ADF as the launch (and possibly sole) customer. The complexity of some of this equipment along with the relatively small domestic Australian market and defence industry compounds the technical, schedule and financial risks associated with these products.

Defence is reluctant to court what it considers to be unnecessary risks associated with local development of new equipment when excellent equipment is available off the shelf from its close allies the UK and USA, and from other sources such as France, Germany and Israel. So Defence prefers to shop higher up the graph in the green ‘MOTS’ ellipse where more mature, lower-risk products are available, generally from overseas suppliers. These have all been developed initially for an overseas customer and then acquired by the ADF off the shelf, or may have been developed in a joint venture with that customer (eg Nulka, JSF and JLTV), or have been evolved from an existing, proven product (Saab’s Anzac frigate CMS, or Combat Management System). These represent relatively low technical, financial and schedule risk to the ADF.

In some cases, Australian industry is a major partner in the international team developing the equipment – for example, BAE Systems Australia leads the Australia-US Nulka decoy team: this is unashamedly an Australian product and a major operational and export success.

The highest risk for Defence lies at the bottom right of the graph, where Australia must either develop, or pay to have developed, a unique, complex and usually expensive capability not available anywhere else, such as a Wedgetail airborne early warning system, a Collins-class submarine or that submarine’s eventual replacement.

This diagram encompasses all the money that Defence will spend acquiring capital equipment for the ADF; it doesn’t include sustainment. It suggests a number of things. Firstly, if Australian industry wants more of Defence’s capital budget it needs to go where that budget is being spent.

Secondly, if Defence needs industry to develop and grow the high-end management, systems integration, repair and upgrade capabilities required simply to sustain equipment that it buys from overseas suppliers, then it needs to ensure local firms get access to the work that will create and grow those capabilities. That work is generally at the front end of a particular project: design, development, systems integration and manufacture. It’s easy from this diagram to see where such work might be in the future, and therefore where industry needs to be positioned to secure a sufficient share of it.
In my previous post I suggested that the greatest potential for change in the Australian defence industry’s circumstances would come through growing the market: by industry either exporting more or tackling defence’s risk-aversion so that it spends more of its money at home.

The latter is a long game and will require, among other things, Defence to lose its fear of becoming responsible, in some way, for industry outcomes and therefore needing to make judgements that will shape industry. The former may offer better prospects of a pay-off in the short to medium term. In order to win both the volume and quality of ‘noble’ work necessary to maintain and grow high levels of skill and capability, Australia’s industry needs to move ‘up the graph’ into the green MOTS ellipse and play a stronger part in developing and manufacturing the equipment in question.

Simple, but not easy. Defence won’t impose an offsets regime that forces overseas suppliers to give work to Australian firms. The current Australian Industry capability (AIC) program requires those overseas prime contractors to make their best efforts to do so but doesn’t mandate an outcome. The result is that nobody has a powerful incentive to help industry to flourish, and there are no real sanctions for failing to do so beyond the damage caused to companies that fail, and to their employees and the industry capabilities they embody.

However, defence industry policy needs to be based on an understanding of how certain specific and very complex skills and capabilities are developed and sustained within a relatively small manufacturing industry community. The fundamental inputs to industry capability include regular, challenging work. Defence’s current policy is based on the Team Australia construct that has worked reasonably well in the case of the F-35 Joint Strike Fighter project. It  needs to help Australian firms move up the graph – and not by simply shoving them up there and mandating work, but by encouraging the development of the industry attributes and behaviours that make choosing Australian firms the wise and rational thing to do. This approach worked fairly well in the F35 JSF project. It could and should work equally well in forthcoming projects such as Sea 1000 and 5000, Land 400 and others.

It would be nice to think the forthcoming Defence Industry Policy Statement will consider some of these factors.

Saturday, April 18, 2015

First Principles Review – implications for Australia’s defence industry

What are the implications for Australia’s defence industry of the impending re-organisation of Defence and the DMO? To frame an answer to that question you need some sense of how Defence, as a customer, currently shapes the industry itself and the market more generally. I’ve discussed some of this in previous Blog posts; the diagram below shows how I believe a number of external forces shape Australia’s defence industry and I’ll explore these forces, and the potential implications of some of the changes in the department, further down the page.

Fundamentally, the industry is shaped by four forces: Defence’s need for high technology; its culture of risk aversion; the relatively small size of Australia’s domestic defence market; and the monopsonistic and monolithic nature of the defence customer. These last two factors in combination, especially when compounded by other factors such as the Customer-Active Paradigm, make the Australian defence market unique.

Defence tries to use technology to compensate for the small size of the ADF: it explicitly seeks equipment which provides it with a capability edge and is generally not available to Australia’s regional neighbours.

Will this change with the reorganisation of Defence and the DMO? Not at all: the drivers of the ADF’s technology demand will remain exactly the same.

However, technology, and the complexity that goes with it, has a price: Defence has suffered many disappointments and much criticism in the past over equipment acquisition projects which have run late or exceeded their budgets. This has made Defence extremely risk-averse and therefore more inclined to buy low-risk products off the shelf, and therefore usually from overseas, rather than take the risk of developing new equipment in-country.

This inclination is reinforced by Australia’s strong alliances with both the USA and the UK and the resulting privileged access it receives to their intelligence, technology and equipment. To some extent also a preference for US equipment, for example, reflects a genuine need for interoperability with Australia’s major ally as well as a need to ensure the health of the alliance. Arguably, a major factor in choosing foreign-manufactured equipment in preference to locally manufactured is often the existence of a logistics supply chain and large organisation to which the ADF can turn in time of war or if it encounters technical problems with its equipment.

Arguably also, the case for an overseas purchase isn’t always tested with appropriate rigour, creating the impression of a ‘lazy default’ which favours imported, off the shelf equipment and tilts the playing field against local industry players seeking to develop new equipment in Australia, or even to play some sort of role in the industrial supply chain.

Will this change? That ‘lazy default’ is a very subjective judgment but is based often on a lack of transparency, and therefore of any contestable logic, in the Defence and government decision-making processes. As long as a Prime Minister or Minister for Defence feels he or she has the right and a reason to make a ‘Captain’s call’, sound process will be at the mercy of political forces, regardless of the capability in question. A community-wide perception that Australian industry is incapable of doing an efficient, economical job simply makes it easier to argue a case for cutting local firms out of the action.

What about a more considered capability development and acquisition process? A couple of ‘IFs’ here -  IF 1) a national debate on industry policy gets under way, embracing defence industry policy also and considering operational capability along with economic and industrial base factors, then there’s a chance that risk-aversion might be mitigated somewhat by a wider debate on the benefits of engaging Australia’s defence industry. And IF 2) the reorganization provides an opportunity for local industry and R&D capabilities to engage better with the end-user and show their worth without being filtered through a separate and disinterested DMO, then again the prospects may be good. In recent weeks it would appear that a sector-wide policy for Australia’s naval shipbuilders and repairers is under active consideration: this may address partially the two ‘IFs’ above. And if this proves to be more than a political expedient and delivers real benefits to the Navy as well as industry it would be nice to think such a policy could be applied more widely across the defence sector.

This all highlights the fact that the Defence market in any nation is a monopsony: the only customer for defence equipment and services is the Government which, through the way it spends its acquisition and research budgets, exercises complete control over the size of the market, its behaviour and the barriers to entry faced by industry players. This won’t change.

Furthermore, Defence is a monolithic customer: if a market exists in Australia for, say, 100 jet fighters capable of carrying out a particular task, aircraft manufacturers will not compete to win a 20 or 30 or 60 per cent market share – Defence will typically buy 100 identical aircraft from a single manufacturer under a single prime contract, though possibly in successive phases or ‘tranches’. Market share becomes a binary value – one hundred per cent, or zero. This has important implications for manufacturers, especially as Defence may not replace these aircraft for 30 years or more – the market is characterised by significant peaks and troughs in demand with significant technology growth between them.

Again, this won’t change. 

The relatively small size of Australia’s defence market means that demand is frequently small so local manufacturers may not achieve economies of scale when developing new products for the ADF and therefore may not be able to compete on price with foreign manufacturers whose larger domestic markets (and possibly other export sales) have helped make their equipment cheaper and have spawned a robust engineering and logistics capability to support it. 

This won’t change: Australian defence spending isn’t likely to grow unexpectedly so the accessible market for Australian defence companies can only grow if Defence spends more of its money on local acquisition, or if Australian firms make significant inroads into export markets and global supply chains – something which Defence has helped with in the past and could usefully do again.

Because of the shaping effects on it Australia’s defence industry has been only intermittently successful in developing sustainable R&D, design, systems integration and manufacturing capabilities along with the management and marketing skills that are required to innovate successfully and compete credibly in the market place. For all these reasons barely 40% of Defence’s equipment acquisition budget finds its way to Australian companies, either directly or indirectly (via overseas pries dealing with local suppliers and sub-contractors). Graeme Dunk’s excellent analyses of DMO capital equipment spending patterns on behalf of ABDIU suggest that even 40% may be hard to sustain into the future unless something changes.

A cursory sensitivity analysis suggests that the greatest beneficial change in Australian industry’s prospects would come from tackling the two things that could change: market size and the risk-aversion of the Defence customer. The former can only change if Australian firms gain better access to export markets and global supply chains, and Defence has a vital enabling role to play in this. To change the latter, industry needs to shoulder the burden of proof, and do so convincingly, in order to attract more of Defence’s attention and then, hopefully, money.

Saturday, April 11, 2015

Defence Innovation - how to predict success

It’s all very well posting earnest blogs about Innovator Attributes and Customer Attributes and all that – but how do they relate to each other? How does one affect the other? And does it matter, anyway?

Well, the short answer is that it does matter: as you’ll see if you read on they add up to a rudimentary model for innovation success – a set of pre-conditions, if you like, that need to be satisfied if the project is to have a decent chance of success. That means you can predict, to some extent, whether or not an innovation project is likely to succeed. Just as important, it provides a framework for a methodical approach to innovation projects and the exercise of professional judgement.

If an innovator understands what it takes, both in organisational and behavioural terms, to be successful then he’s better able to achieve that success. Similarly, in Australia’s defence market, if the customer understands what it takes to be a good customer in a high-technology developmental project then his chances of actually getting his hands on a good piece of kit at a reasonable price and within a reasonable time frame improve considerably.

The diagram below shows how these major forces intersect in a defence product innovation project.

This object-oriented model for Product Innovation Success in the Australian Defence Industry pulls together the five factors I’ve discussed in previous posts: Customer Attributes and Customer-Controlled Factors; Market Environment; and Innovator Attributes and Innovator Behaviours. The model shows how these five groups of factors relate to each other and shape the product innovation outcome.

The existence of the Customer-Active Paradigm (CAP) within Australia’s defence market monopsony means the innovation process resembles to some degree a closed cycle. Furthermore, in a monopsony and monolithic market such as defence the customer shapes the Market Environment and controls market behaviour to a significant degree.

This is the first model, to my knowledge, which attempts to integrate the CAP into a general model for Product Innovation Success in the defence industry and visualise the mechanisms by which it shapes the outcome. Its value lies, firstly, in the way it acknowledges the monopsony nature of the defence market, the paramountcy of the CAP and the resulting primacy of the Customer Requirement within it: the entire innovation process begins and ends with the customer and his operational requirement. 

Secondly, it places the innovator at the heart of the process: Customer Attributes, Customer Controlled Factors and Market Environment represent external forces acting on the innovator.

A successful innovation outcome is the product of Innovator Behaviour, influenced and shaped by intrinsic Innovator Attributes and the three external forces acting on him. And just as Innovator Behaviour is shaped by Innovator Attributes, so Customer Attributes shape to some degree both the Customer Controlled Factors and, due to the CAP and the customer’s monopsony status, the Market Environment. This means the innate characteristics of the customer are an important factor in determining product innovation outcomes in such a market.

If you’re a real glutton for punishment you could read my doctoral thesis. I can save you a bit of time and effort by pointing you to a couple of highlights: if you drill down into each of the five groups of factors that make up the diagram above, you discover (well I did, anyway) over 60 separate sub-factors that have some bearing on product innovation outcomes. They don’t all apply equally to all cases so you need to use a bit of judgement (informed by professional and technical mastery) in their application, but you do need to consider them. And probably others – this field of research hasn’t really been explored properly , in my view.

In any case, the ability to go through the 62 factors methodically and consider them all in the context of whichever project you’re involved in, or even just contemplating, gives you a rudimentary model for product innovation success. They represent a check list of preconditions which need to be satisfied – or at least examined for their relevance in a specific context – in order to maximise the chances of success.

This ‘model’ therefore has a predictive function. If the preconditions are satisfied then there is a greater likelihood of the project succeeding. Of course, plenty of projects succeed against the odds: history is replete with successful mavericks who break lots of rules, and nobody can offer a guarantee of success - I certainly don’t! And while not all factors will be critical to all projects, completing this check list is important for two reasons: first, it requires the innovator to take a methodical approach to the innovation process; and second, it requires him to identify attributes and behaviours which require change or improvement in some fashion in order to enhance his prospects for success.

It also provides a yardstick by which external stakeholders in government or the financial community can check the prospects and the ongoing health of a project.

Each opportunity to innovate is different - in scale, in technology domain, in market sector and even in the innovator’s own motivation. This model may not apply equally to all defence projects, but it does provide a framework within which the innovator can use his own judgement, informed by his market and customer knowledge and his own expertise and technical and business proficiency. It also prompts him to test his knowledge and proficiency: as much as anything else it is a challenge to complacency.

This Blog Post, and the ones preceding it this year, are based on my doctoral research at the University of Adelaide - I completed my Ph.D Thesis on Product Innovation Success in the Australian Defence Industry in 2012. The complete model is there.

Saturday, April 4, 2015

Defence Innovation - How to be a Good Customer

Plenty of people seem to be jumping on the ‘Innovation’ band wagon at present, including the Australian Department of Defence. There’s a general acknowledgement that Innovation is a good thing, but one wonders how widely it is understood; and one wonders whether the role of the customer in the innovation process is properly understood, or even acknowledged.

In Australia (and in most other developed nations) the defence market is shaped by the Customer-Active Paradigm (CAP), identified by Eric Von Hippel, who studied the role played by customers in determining and defining the need for innovation. This is typical of markets where equipment users consist of a community of expert practitioners whose specialist knowledge is essential to the development of new tools or methods. Von Hippel concluded that the CAP cannot apply where the user is ignorant of his needs, while the opposite case, the Manufacturer-Active Paradigm, or MAP, cannot apply where the point of need is inaccessible by the manufacturer – which is often the case in the defence market.

Given the necessary secrecy with which defence forces draw up their threat assessments and strategies, and then their requirements for equipment and services, it was a reasonable hypothesis that the CAP applies in the defence market and therefore shapes the product innovation process. And this was confirmed by my Ph.D research.

In fact, in Australia the effect of the CAP is amplified by the monopsony nature of the defence market: there is only one customer for defence goods and services and so, through his budget and his procurement policies, he determines the size and behaviour of the market and any barriers to entry.

Long story short: the CAP manifests itself in three features of the defence market and the innovation process: Customer Attributes; Customer Controlled Factors (these include Customer Behaviours); and the customer’s shaping effect on the Market Environment.

A very topical example of the third is the Australian government’s announcement in early 2015 of the acquisition process for the Royal Australian Navy’s Future Submarine. It was announced that only three nations were considered suitable as potential strategic partners for Australia in this venture: France, Germany and Japan. To the intense surprise of many submarine industry specialists, a fourth country, Sweden, was deliberately omitted from this list. This announcement immediately narrowed the field from which the customer could source equipment and expertise as well as reducing the number of supply chain opportunities potentially open to innovative Australian suppliers and sub-contractors.

Customer Attributes, as I define the term, are those features of the defence customer that are intrinsic. That is, they are an organic part of his make-up, or which are so embedded in it that they can be changed only slowly, if at all. At their core are the technical and professional expertise of the customer. In the case of a submarine purchase, for example, does the customer understand sea power, its role in strategic security and the means by which it is exercised and applied? And does he understand submarines? That includes technical know-how and operating expertise: how they work, how they are made and how to use them properly (and how to train the people who use them); and does he also understand anti-submarine warfare? None of this expertise is created rapidly and must be grown deliberately, and nurtured.

Looking at professional expertise from a different viewpoint, does the customer undertake R&D in a strategic and systematic fashion? Does he understand and embrace the imperatives and opportunities of change? Can he contemplate the inherent risk in a new submarine project, but avoid becoming so self-protective that he loses sight of the objective, and foregoes the prize that comes with it? That sort of professional expertise and confidence takes time to build.

Customer-Controlled Factors include Customer Behaviours but extend beyond this. The Behaviours are the things the customer does: things that can  be learned, changed and even discarded relatively quickly or easily, for example by changing procedures, training staff or recruiting individuals with specific skills or knowledge. Or, with a stroke of the pen, by changing government policy.
They include obvious things like conducting modelling and simulation activities to validate an operational requirement; engaging with potential industry suppliers to determine what’s actually available, or credibly possible; appointing a senior internal champion to steer the project to completion; developing an acquisition strategy that acknowledges risk, mitigates it, but isn’t blinded by it; and applying some discipline to the entire process so that requirements and specifications don’t keep shifting. These are hardly a surprise.

But additional factors include things like the perceived urgency of a stated need, the consequences for the industry of the timing of a purchase (does this help sustain an essential capability, maintain economies of scale to reduce costs, or assist with export marketing and sales?) and even a decision to support (or not, as the case may be) an indigenous company that needs export sales to help it grow and therefore maintain and enhance what may be an important local industry capability. These factors, and the way they play out in the capability development and acquisition process, can have a significant bearing on the outcome of a product innovation project.

The Market Environment is a combination of external ‘shapers’ of the innovation market. These include classic market features such as levels of demand, customer budgets, levels of competition in the market place, and so on. In a high-technology marketplace they also include things like technology development, levels of R&D and sources of Intellectual Property (IP). In the defence market specifically, they must include things like the evolution of the threat environment (possibly a function of technology development) and the tempo of operations.

The CAP amplifies these considerably: the market environment, as it is perceived by the innovating company, is shaped by the customer’s response to real or perceived changes in the threat environment, and his response to the threats and opportunities thrown up by technological change. A government may consider a certain casualty rate in a counter-insurgency campaign quite acceptable, for instance, and therefore refuse to countenance buying new protected vehicles for its troops or up-armouring the vehicles in service. The introduction of a new, more lethal weapon by the enemy may force a change. It may stimulate a sense of urgency; or it may not. Whatever is happening in the outside world, in a monopsony the market forces that might otherwise drive innovation and the development of new products and services are moderated and channelled by the customer.

So what are the rules a defence customer should follow if he wants new equipment projects to have a reasonable chance of success?
1.     Nurture and grow your technical expertise
2.     Nurture and grow your professional expertise
3.     Maintain your situational awareness: keep abreast of emerging threats as well as merging technologies and their potential effects on your own operations
4.     Understand your needs and articulate them properly
5.     Be methodical in conducting R&D: this will help you understand your needs, as well as helping you identify solutions
6.     Seek opportunities for innovation in your organisational practices and processes as well as in your equipment inventory
7.     Be aware of risk (see 1 and 2 above), but remember that obsessive risk-aversion is itself another source of risk
8.     If it needs to be done at all, do it quickly. Urgency eliminates irrelevancy: a short deadline ensures a focus on the outcome, not the process
9.     Establish a disciplined acquisition strategy that both reflects the urgency of the need and tolerates sensible risks (see 1 and 2 above)
10.  Appoint a champion with sufficient seniority to drive the project forward – or to kill it, if this turns out to be the correct course of action; and give him or her the best possible project team
11.  Make sure you’re nurturing your industry base – In a  technology driven monopsony a smart customer doesn’t allow his industry base to fall into a technical rut or to fall behind in a technology sense. 
12.  Nurture a culture and capacity to work with your industry base to identify opportunities and develop solutions, both for yourself and also, potentially, for allies and export customers.

Coincidentally, as I was working on this set of rules, the Minister for Defence released the report and recommendations from his First Principles Review of Defence. One of the key recommendations was the abolition of Defence’s Capability Development Group (CDG) and Defence Materiel Organisation (DMO) and their replacement with a new Capability Acquisition and Sustainment Group. Six of the report’s eight recommendations are:
  • Abolition of the Capability Development Group and the Defence Materiel Organisation in their current form;
  • Creation of a Capability Acquisition and Sustainment Group under a Deputy Secretary reporting to the Secretary;
  • Moving to a leaner ‘smart buyer’ model that better leverages industry, is more commercially oriented and delivers value for money;
  • Strengthening the front end of the capability development life cycle by revising the two pass process, establishing an entry gate and creating more opportunity to tailor and fast track projects;
  • Strengthening and placing at arm’s-length a continuous contestability function that operates throughout the capability development life cycle from concept to disposal; and
  • Transferring accountability for requirements setting and management to the Vice Chief of the Defence Force and the Service Chiefs within a regime of strong, arm’s-length contestability.

These changes, if implemented successfully, would have the benefit of integrating more closely the end user, the purchaser and the supplier. In any sort of developmental project this relationship needs to be close; it needs also to be moderated externally, however, so that the project and its participants remain grounded and that no ‘at all costs’ mentality or ‘conspiracy of optimism’ emerges; the fifth and sixth dot points above recommend establishing this function in a reshaped bureaucracy. An implicit assumption (and for me a necessary condition) is that the senior ADF officers and other officials who are empowered by these changes embody the professional and technical skills required.

Overall, the First Principles Review seems to acknowledge the importance of professional and technical mastery within the ADF and the wider Defence Department and how these are necessary to shape the capability development and acquisition process and therefore, hopefully, capture the rewards resulting from a better (and better managed) process.