Introduction

1. Defence force recruitment is a major undertaking given the size of the Australian Defence Force (ADF) (some 55 081 permanent and 20 277 Reserve personnel as at 30 June 2009), the diverse range of personnel required by the three Services—the Navy, the Army and the Air Force—and the fact that Defence must compete with Australian business and industry to attract the required recruits, both skilled and unskilled.

2. Defence Force Recruiting (DFR) Branch, the responsible area within Defence, delivers recruitment services to the ADF with the assistance of a recruiting services prime contractor, a range of subcontractors to the prime contractor and the Defence Support Group (DSG), which provides the Defence Service Centre (DSC) (a call centre in Cooma). Recruitment directives (targets) are developed by Defence to meet future ADF capability requirements. DFR Branch aims to meet these targets under a single, major contract that provides for recruiting services to be delivered by 16 Defence Force Recruiting Centres (DFRCs) (jointly staffed by both personnel employed by the prime contractor and ADF personnel) and a dedicated Candidate Relationship Management Centre (staffed by the prime contractor's personnel), with the support of the DSC operated by DSG personnel.

3. As at 10 March 2010, Defence employed 232 full-time ADF personnel and 26 Defence Australian Public Service (APS) personnel to deliver Defence Force Recruiting (DFR); and Manpower Services (Australia) Pty Ltd (Manpower), the current prime contractor, employed an additional 330 permanent and 113 casual or contract personnel. The DSC employs around 72 full-time and nine part-time APS personnel to manage a range of call centre activities for Defence, including initial call reception for Defence Force Recruiting. The number of stakeholders involved in delivering defence force recruitment services, and shared responsibilities, adds to its complexity from a management and resourcing perspective.

New recruiting service delivery model

4. During 2007–08, Defence began working with its then prime contractor for recruiting services, Manpower, on implementing a new recruiting service delivery model (the New DFR model). At the same time, the department was also undertaking an open tender process for a contractor to deliver recruiting services into the future under the New DFR Recruiting Services Contract (the New DFR Contract). The changes to the service delivery model were incorporated into the New DFR Contract and the model was fully implemented nationally by 20 November 2008.

5. On 2 July 2008, Defence signed a contract with the successful tenderer Chandler Macleod Group (CMG). From 1 February 2009, following a seven month transition period, CMG took over the provision of ADF recruiting services. The contract was for a five year term ending on 1 February 2014. In July 2008, the then Minister for Defence, Science and Personnel announced that the total estimated cost of this contract over its five year term would be up to $405 million. However, Defence and CMG agreed in October 2009 after only 9 months of operation, subject to the satisfaction of certain conditions, to the early termination of the contract. From 1 February 2010, Manpower took over the provision of ADF recruiting services under an interim contract until March 2012.

6. In entering into the New DFR Contract each party could be expected to look after its own position. Defence constructed a contract which transferred a high level of risk to the contractor and CMG signed the contract in the full knowledge of the terms of the contract. Each party was responsible for undertaking their own inquiries and assessing the implications for their ongoing operations of signing the New DFR Contract.

Audit objective and criteria

7. The objective of the audit was to assess whether Defence effectively managed the procurement process for services related to the recruitment of personnel to the ADF and the introduction of a new service provider. In addition to examining the procurement process itself, the audit specifically assessed whether Defence effectively managed the:

• seven month transition period (July 2008–January 2009) between the recruiting services contractors (Manpower and CMG); and
• contractual difficulties with CMG, including any operational impact, and the resolution of those matters to the extent that had occurred by the end of the audit.

8. Originally, the audit approach was intended to have a broader scope that also included an examination of:

• Defence's management of performance monitoring frameworks for ADF recruitment; and
• the progress made in implementing major recruitment reforms for the better management of ADF candidates.

9. However, following Defence's advice to the ANAO during the early stages of the audit about unresolved commercial matters between Defence and CMG, the audit's scope was adjusted to take account of the changed circumstances.

10. The ANAO plans to include a further performance audit of ADF recruitment in its forward audit work program that will provide coverage of: DFR's performance monitoring frameworks; establishment of the Candidate Relationship Management Centre (CRMC), a major recruiting reform; Defence's management of the process to obtain an interim recruiting services contractor (Manpower); and Defence's management of that contract and its planning for the future ADF recruiting services model.

Overall conclusion

11. The period since Defence and CMG signed the New DFR Contract on 2 July 2008 for the delivery of ADF recruiting services has been challenging for both parties. In transitioning to the management of the New DFR Contract, CMG faced a range of pressures in delivering the ADF recruiting services it had contracted to provide for the agreed price, particularly when also affected by the global economic downturn. For its part, Defence was bedding down a new recruiting service delivery model and transitioning to a new service provider for DFR services. As events unfolded, within the context of the New DFR Contract, Defence and CMG were unable to agree a way forward which CMG considered would allow it to successfully complete the five year contract for the delivery of DFR services while also meeting Defence's requirement that CMG deliver the contract in accordance with the agreed terms, including price, of the New DFR Contract.

12. On 2 October 2009, Defence and CMG signed a Termination Deed in relation to the New DFR contract that, subject to a condition precedent being met, provided for CMG to cease providing DFR services from 1 February 2010. On 14 December 2009, Defence and Manpower signed a contract for Manpower to provide DFR services from 1 February 2010 until March 2012. Defence and its contractors have ensured that, throughout the disruptions of changing provider twice, only 12 months apart, the DFR recruiting process itself has continued to function on an uninterrupted basis.

13. Defence generally followed appropriate guidance in planning the tender process for the New DFR Contract and evaluating the proposals received from tenderers. However, aspects of the data and information underpinning the tender process, which had been provided to tenderers to inform their proposals, were not accurate or complete (for example, information on IT systems). During contractual negotiations, Defence sought to maintain a low level of risk exposure for the department and was successful in transferring certain key risks to CMG under the New DFR Contract. However, it is not clear that CMG had sufficiently priced its acceptance of these risks in signing the contract.

14. During the transition in period for the New DFR Contract, CMG raised a number of concerns with Defence (largely relating to costs that it had not anticipated). Defence informed the ANAO that, in the context of discussions with CMG about these matters, it suggested to the company that it prepare and submit to Defence a ‘commercial plea' outlining its concerns, the basis for them and the remedies it was seeking.

15. Subsequently, CMG submitted a ‘without prejudice' submission to Defence on 30 January 2009 which claimed that the New DFR contract did not reflect the commercial arrangement understood by the parties upon signing, and that the business and operations of DFR were not able to be understood by CMG prior to entering the New DFR Contract. CMG's ‘without prejudice' submission also included examples of additional costs and liabilities CMG claimed it discovered during transition in (for example, ‘make good' obligations under certain facility leases, relocation expenses on lease expiry, costs associated with meeting applicable security standards and the costs of rectifying existing IT infrastructure).

16. Adding complexity to the resolution of issues, Defence had concerns regarding the financial position of CMG and sought advice from its financial adviser regarding the financial viability of CMG. Defence continued to monitor CMG's financial position in the first part of 2009. CMG stated in a trading update (19 May 2009) to the Australian Stock Exchange that the financial outcome of the New DFR Contract was not in line with its original expectations. At the same time, Defence was aware of the effect of deteriorating global financial conditions on many sectors in the Australian economy and the impact that this would have on firms within the recruitment industry.

17. Once it became evident that there were serious differences between itself and CMG, Defence sought appropriate advice from its legal and financial advisors regarding the course ahead. Defence was careful in the negotiation of the Termination Deed not to countenance any claims by CMG clearly outside the original intent of the New DFR Contract and gave appropriate weight to the advice of its advisors.

18. In its ‘without prejudice' submission of 30 January 2009, CMG made a broad claim for increased revenues (primarily through increased reimbursable costs) which, in accordance with the terms of the New DFR Contract, Defence rejected. In May 2009, CMG also claimed that weaknesses in the New DFR model itself (relating to the operation of the DSC and the new DFR system's inability to handle the number of inquiries being experienced) limited its ability to achieve 10 500 enlistments in a year.

19. During the course of 2009, another issue arose that would have had to be dealt with in relation to the terms of the New DFR Contract had it continued to operate. DFR recruiting targets were reduced and, currently, they are continuing to fall. This is chiefly as a result of significant improvements in both recruiting achievement and retention rates in the ADF, most probably due in part at least to the effects of the global economic crisis and Defence's enhanced recruitment and retention program. Defence has ensured in its contracts with private sector providers that any decision as to the level of ADF recruiting targets is solely in the discretion of the department. However, the revenue available to CMG under the New DFR Contract was heavily reliant on the numbers of candidates to be recruited and did not provide the company with any protection in the event Defence reduced targets below that expected when the company tendered for this contract. In circumstances where retention rates are lower than desired, which had been the case for many years in the ADF, there is little risk that recruiting targets will be significantly reduced. However, in light of improved recruiting achievement and retention rates in the ADF during the latter half of 2009 and 2010, Defence has reduced recruiting targets.

20. By the time Defence was negotiating the Interim Contract it signed with Manpower in December 2009, the department had recognised the need to provide the contractor with some protection in the face of the prospect of reductions in ADF recruitment targets. The solution adopted in the Interim Contract was the adoption of a banded pricing approach which allows for the contractor to receive higher fixed and per head recruitment fees when Defence's recruitment target is less than 9500. In response to the proposed audit report, Defence noted that this issue did not eventuate during the period [preceding the mutual decision] to pursue an early termination of the contract, and Defence did not consider that this was a factor leading to CMG's ‘without prejudice' submission. However, CMG informed the ANAO that, during negotiations with Defence subsequent to the submission of its ‘without prejudice' submission and prior to the mutual decision to terminate the New DFR Contract, the company did raise with Defence the issue of the potential impact of falling recruitment targets on the revenue available under the New DFR Contract.

21. Noting that a mutual agreement between Defence and CMG to terminate the New DFR Contract would necessarily involve a range of costs for the department, an alternative option that Defence could have explored would have been for the Department to agree to provide CMG with some short term financial relief until a new tender for a replacement DFR contract, with different pricing arrangements, could be called. In explaining its course of action in not seeking to explore this option with CMG, Defence has indicated that it considers there was a real prospect that if CMG was to continue as DFR provider for the remainder of the New DFR Contract term, even under amended terms, that further performance issues and claims would arise, and there was a significant risk of the ultimate failure of the whole contract.

22. Factors within the control of both parties contributed to the contractual difficulties encountered during transition to the New DFR Contract. As the impact of the global economic crisis deepened, some of these difficulties intensified. Defence did not have sufficient knowledge of key aspects of the contractual arrangements under the previous DFR contract with Manpower (for example, in relation to Information Technology and DFR premises). For its part, CMG has referred to a projected shortfall in revenue due to a lower level of recruits and a number of unanticipated costs contributing to a projected loss on the New DFR Contract for the year ended 30 June 2009. In early 2010, in explaining how this situation had developed, CMG informed the ANAO that it had not fully comprehended the risks it was assuming in signing the contract.

23. The cost to Defence of the early termination of the New DFR contract and bringing in an alternate supplier is expected to be $12.1 million (excluding GST). In addition Defence will be paying a premium for DFR services over the next two years.

24. The ANAO considers Defence could strengthen future DFR contracting processes by recognising in the contractual arrangements the mutual dependencies between Defence and the contractor, the areas of DFR performance that both the contractor and Defence contribute to and the need to make sure that risks transferred to the contractor are matters on which they could reasonably be expected to mitigate the impact of adverse events (for example, the appointment of key personnel and IT systems availability). Where factors affecting the operation of a contract require the ‘management of uncertainty' (possibly involving changes to economic conditions or government policies), there is a case for the department to retain responsibility for managing such factors, or at least to frame its contractual arrangements such that the full impact of the uncertainty does not fall on its private sector partner to manage. The pricing elements of any future long term contract would benefit from the inclusion of a sliding scale for certain elements of contract pricing, based on different levels of recruitment targets.

25. Preparation for any future procurement should include making sure that data within material provided to tenderers is accurate and complete. Resolving differences in underlying data and information that become known after contract signature would be assisted by the introduction of a formal due diligence period. In addition, Defence must have sufficient in-house knowledge and expertise to support both the day-to-day and strategic ongoing management of DFR contracting arrangements.

Key findings by Chapter

Defence Force Recruiting Model (Chapter 2)

26. Fundamental to the operation of the New DFR model is collaboration between Defence and its prime contractor. The prime contractor and Defence both contribute to the overall recruitment process, which commences when a candidate makes their initial inquiry or application and concludes with their possible enlistment. Defence personnel undertake key interviews during the recruitment process and make final selection decisions.
27. In the six months to 31 December 2009, the average length of time taken to process applications for general enlistment was high (49 weeks compared to a target for 2009–10 of 6 weeks). The target was based on an efficiency measure put forward to Government by Defence in 2006, as part of a proposal to reduce the length of time taken for the recruitment process. However, the efficiency of the recruitment process was much worse in the last six months of 2009 (49 weeks) than in 2006 (30 weeks). Defence informed the ANAO that:

the period covered by this measure does not represent recruitment processing time only (which increased from 19 weeks to 23 weeks over the same period), and that a substantial increase in the number of enquiries received during 2008 and 2009, especially from uncommitted candidates, has extended processing times. Extended recruitment processing times have the potential to adversely affect candidates (and as [a] consequence, recruiting target achievement), the contractor's costs and Defence's interests. Despite the increase in recruitment processing times between 2006 and 2009, recruiting target achievement has increased significantly, whilst the average cost per recruit has been maintained at 2006 levels. This suggests the current efficiency measure may need to be reviewed.

28. Neither the New DFR Contract or the current Interim Contract, reflects the Key Performance Indicators (KPIs) that both Defence and the contractor contribute to (for example, recruitment performance) and those that are solely the responsibility of the contractor (for example, IT systems availability). The recruiting services contract would benefit from recognition being made within it of the KPIs to which Defence contributes.

29. Defence has ensured in its contracts with private sector providers of recruiting services that any decision as to the level of ADF recruiting targets is solely at the discretion of the department. However, the revenue available to CMG under the New DFR Contract was heavily reliant on the numbers of candidates to be recruited and did not provide the company with any protection in the event Defence reduced targets below that expected when the company tendered for this contract. A form of sliding scale in tenderer pricing for certain pricing elements, based upon different assumptions regarding the target levels of recruitment that Defence may set, would provide the necessary protection. In addition, the New DFR contract did not incorporate a ‘gain share' arrangement to help promote efficiencies and economies, including through innovation. Defence informed the ANAO that it was satisfied with existing continuous improvement provisions which already existed within the New DFR Contract. However, there is scope with future contracts for Defence to build on existing continuous improvement provisions and include a form of sliding scale for pricing in any longer term recruitment contracts as it has in the Interim Contract with Manpower.

New DFR Contract Procurement (Chapter 3)

30. The Commonwealth Procurement Guidelines (CPGs) form part of the procurement policy framework for all Australian government agencies and the Defence Procurement Policy Manual (DPPM) contains specific policy and guidance for Defence officials to refer to. Defence produced a comprehensive set of procurement planning documents for the new DFR tender process that were consistent with the requirements contained in the DPPM and CPGs. Defence's actual conduct of the tender process was generally consistent with the requirements of the CPGs. However, Defence was not in a position to provide complete and accurate advice to tenderers, and was unable to respond fully to the tenderers' clarification questions during the Request for Tender (RFT) process (see paragraphs 3.27 and 3.28). Some of the matters which related to this weakness in the tender (for example, in relation to DFR premises and IT systems) were factors within the contractual issues that arose between Defence and CMG later in 2008–09 (see Chapters 4 and 5 for details).

31. The Invitation to Register Interest (ITR) evaluation plan and evaluation report were consistent with the ITR documentation released by Defence. Similarly, the RFT evaluation plan and the Preliminary Source Evaluation Report (PSER) were consistent with the RFT documentation released by Defence to the tenderers.

32. Defence identified a number of financial risks for the Commonwealth associated with the New DFR procurement and acted to mitigate those financial risks during the tender process. However, the RFT evaluation would have benefited from analysis of the sensitivity of tenderers' bids to the impact of potential decisions by Defence over the term of the contract to vary recruitment targets to take account of changes in the ADF's requirements, and the risks such potential changes presented for Defence and any contractor. Any sensitivity analysis could also have examined the impact on tenderers' pricing proposals of variations in their success in meeting recruitment targets from the levels assumed in their tender. Such considerations could have informed decisions on the final terms of the contract.

33. The contractual negotiations were generally completed within Defence's estimated timeframe for contract signature and were consistent with the content and guidance in the approved contract negotiation directive (see paragraphs 3.69 to 3.72). During the contractual negotiations, Defence sought to maintain a low level of risk exposure under the contract. Defence was successful in transferring certain key risks to CMG, although it is not clear whether CMG had sufficiently priced its acceptance of these risks in signing the contract. In designing a contract and pursuing contract negotiations it is important to recognise that assigning risks to a contractor without it being in a position to properly mitigate these risks, and thus reduce their likelihood of coming to fruition, is likely to affect the contractor's pricing approach, and potentially a contract's viability if not effectively priced by the contractor.

Managing Contract Transition (Chapter 4)

34. Defence's general approach to the transition period between contractors was consistent with sound practice for managing a transition phase in contracts, including the importance of ensuring a smooth transition, establishing relationships, systems and procedures, and transferring information and assets between contractors. Defence made payments to CMG during the transition period from July 2008 to January 2009 in accordance with the New DFR Contract.

35. Of the issues that arose during the transition period, the two most challenging for Defence to manage were those surrounding DFR's IT systems and facilities' arrangements. A lack of sufficiently rigorous preparation activities by Defence to finalise all of the obligations and rights existing under the then DFR contract with Manpower, and in preparation for the tender, contributed to the severity of the issues that arose.

36. The Director-General, Defence Force Recruiting (DGDFR) (the ADF head of DFR) changed on 3 July 2008 (one day after signature of the New DFR Contract) and again on 1 February 2010 (when Manpower re-commenced providing DFR services). The impact of the posting cycle on senior ADF management poses particular risks for Defence that require careful management. In addition, CMG announced the appointment of a new Managing Director and Chief Executive Officer on 3 July 2008, the day after the New DFR Contract was signed. As a consequence, both parties to the contract had changed their senior leadership between the tender submission, assessment and contract negotiation period, and the period during which CMG undertook transition towards contract management.

37. At the end of the seven month transition period on 1 February 2009, when CMG assumed full responsibility for the delivery of services under the New DFR Contract, a number of significant issues remained unresolved in addition to the ongoing issues with the IT systems and facilities. As a result, it was not until September 2009, eight months after the formal handover between the contractors, that all transition period activities were considered by Defence to have been completed. Some of the underlying issues were ultimately dealt with in the context of the termination of the New DFR Contract. If the New DFR Contract had provided for a formal due diligence period (as do some other Defence contracts for the provision of services), Defence would have been better placed to deal with these issues in a timely and planned manner. Such a provision would allow for limited revisions to be made to costing and pricing arrangements in the light of factors not known at the time of contract signature.

38. During the transition period from July 2008 to January 2009, recruitment target achievement varied from 68 per cent to 80 per cent. In an earlier comparable period, July 2007 to January 2008, target achievement varied between 76 per cent and 90 per cent. However, there were no breaks in the delivery of DFR services during the transition period.

Termination of the Recruitment Services Contract (Chapter 5)

39. On 30 January 2009, CMG made a ‘without prejudice' submission to Defence which claimed that the New DFR contract did not reflect the commercial arrangement understood by the parties upon signing, and that the business and operations of DFR were not able to be understood by CMG prior to entering the New DFR Contract. CMG's ‘without prejudice' submission also included examples of additional costs and liabilities (related to matters such as facilities, security and IT) which CMG claimed it discovered during transition in. After some months of discussions on the matters raised in CMG's submission, Defence and CMG agreed to discussions on mutually terminating the New DFR Contract. The two parties signed a Termination Deed on 2 October 2009 and an Amending Deed on 11 December 2009.

40. Notwithstanding the weaknesses that existed in the original tender processes (see paragraph 30), Defence adopted a prudent response to the 'without prejudice' submission from CMG. Weaknesses in the original tender process resulted in Defence having to make additional financial commitments to the operation of the New DFR arrangements. Matters that Defence considered as part of this process included the need to ensure the ongoing provision of recruiting services, deficiencies in the data supporting the original tender process, and the need to maintain the integrity of the original tender and its assessment. Defence rejected the claim by CMG that the contract be amended to include a broad provision for the reimbursement of costs incurred in providing DFR services. As a consequence of its overall consideration of CMG's ‘without prejudice' submission, Defence agreed to meet additional costs totalling $1.6 million (excluding GST). In the end, payment for these costs formed part of the termination payment.

41. Performance of the recruitment process in the first part of 2009, in terms of achievement against target, was not at a level that was anticipated by Defence during the tender process. Factors affecting this situation were the increased level of interest in joining the ADF during 2009, and the resultant difficulties in managing the recruitment pipeline. To the extent possible, within the constraints of the New DFR Contract, Defence took steps to help improve the performance of the recruitment process through providing additional CRMC staff and also through the short term use of additional ADF staff in the DFRCs. Defence also met certain other leasing costs associated with office space in Melbourne. In the second half of 2009, CMG's recruitment performance against target was considerably improved. The recruitment target for the seven months to 31 January 2010 was 7.3 per cent less than the target for the comparable period 12 months earlier, although the actual number of enlistments (excluding Gap Year entry) grew by 558 in the more recent period.

42. Defence was careful in the negotiation of the termination deed not to countenance any of the claims made by CMG that clearly were outside the original intent of the New DFR Contract. From the available evidence, Defence also gave appropriate weight to the views of its legal advisers that were involved on a regular basis throughout the negotiation of the termination. Nevertheless, Defence has had to make payments of $12.1 million (excluding GST) associated with the termination arrangements and to put in place an alternative provider.

43. An amount of $8.2 million (excluding GST) of this $12.1 million (excluding GST) relates to transition in payments made to Manpower in respect of the Interim Contract (under which it assumed responsibility for providing full DFR recruiting services from 1 February 2010). The transition in payments to Manpower included $3.1 million (excluding GST) related to the work of sub-contractors engaged by Manpower to deliver certain services for DFR during the period 21 December 2009 to 31 January 2010. Under the New DFR Contract, CMG was also paid for the delivery of these services over this period as part of the fees paid even though Manpower had assumed responsibility for delivery by the sub-contractors. Accordingly, to facilitate the termination of the New DFR Contract and transition in of its interim provider, Defence has effectively paid twice for certain services between 21 December 2009 and 31 January 2010.

44. As part of the resources used in the management of the transition in of CMG, ongoing management of the New DFR Contract and the arrangements for the transition out of CMG, Defence has been reliant on the services of consultants to undertake key day-to-day tasks. This heavy reliance on external consultants is an issue to be managed by Defence to ensure it has sufficient in-house knowledge and expertise within its in-house resources to satisfactorily manage the DFR contractual arrangements.

Responses to the proposed report

45. In addition to providing a copy of the proposed report to Defence for comment, the ANAO also provided the proposed report to CMG, and a relevant extract to Manpower, for comment. Neither company elected to provide substantive comments for publication in the final audit report. However, CMG's views have been reflected as requested at relevant points in the Summary and body of the report.

46. Defence's detailed responses to each of the audit's six recommendations are set out in the body of the report underneath the relevant recommendation. Defence also provided the following overall response to the proposed audit report:

Defence welcomes the ANAO audit report on Contracting for Defence Force Recruiting Services. This audit examined a period where Defence Force Recruiting was managing an unusual set of circumstances, including: the major procurement of a prime contractor to deliver a new recruiting service delivery model; the subsequent impact of the Global Financial Crisis both on the recruitment sector and Defence Force Recruiting; a request by Defence's prime contractor to terminate their contract during its first year of operation; and the subsequent procurement of, and transition to, an interim contract arrangement.

There have been a number of lessons for Defence throughout this period and action has already commenced to implement the ANAO's recommendations. Defence notes that during this challenging period its highest priority has been to ensure that recruiting operations were not adversely affected. Despite the contractual difficulties, in 2009–10 Defence delivered the highest levels of recruiting target achievement in more than a decade. Through the Audit process, Defence has been able to identify areas that will assist increasing recruiting performance as well as informing improved practices that will be used in future contract arrangements.