Background

1. The Royal Australian Navy (RAN) currently operates 15 Fremantle Class Patrol Boats (FCPBs), which have exceeded their designed life of type by in excess of six years. In October 2002, the Government approved a Capital Acquisition Project, Project Sea 1444, with an acquisition Project Budget of $436.8 million, to provide a replacement Patrol Boat capability.¹ The approved Project Budget has increased by $17.6 million, as a result of price and exchange variations, to $454.4 million, in September 2004.

2. Following a competitive tender process, Defence signed a contract with Defence Maritime Services Pty. Ltd. (the Contractor)² in December 2003, worth $552.86 million, to deliver and maintain 12 Armidale Class Patrol Boats (ACPBs) for 15 years, with a five year extension option. The cost of the acquisition component of the Contract was approximately three-fifths, and the whole of life in-service support element was approximately two-fifths, of the total contract value. The ACPBs are being built in Fremantle, Western Australia, by Austal Ships Pty Ltd (the Ship Builder), as a sub-contractor.

3. Defence considered two innovative acquisition options, namely: direct purchase, with contracted in-service support under the same contractual vehicle; and a Private Financing Initiative (PFI). The PFI model involved private sector owned and supported boats, delivered and supported to meet defined output performance terms. Implementing this style of capability delivery mechanism for the RAN had implications for the allocation of risk, and how the lease transaction would be classified. Following direction from the Government in June 2002, Defence chose the direct purchase model, as the preferred option, to acquire the ACPB capability.

4. The 12 ACPBs will be required to deliver up to 3600 sea days per year, and will be operated by 18 separate RAN crews.³ The ACPB capability is being delivered as a fixed cost build contract, followed by a fixed cost in-service support contract to maintain the availability of the specified capability requirements. The same Contractor is responsible for delivering both the build program and the in-service capability which, in principle, serves to provide an arrangement where the risks associated with delivering a less than reliable ship are borne by the Contractor, through loss of profits during the in-service phase of the Contract. Payment for in-service support will be based on a single fee per day, for the ships that are made available.

5. The ACPBs, when delivered, will be designed, constructed and maintained to commercially-based classification society⁴ rules, under full survey, supplemented by Navy technical regulatory and safety rules, where required to meet Naval requirements.⁵

6. Complementary infrastructure projects, not within the control of the ACPB Project, yet contributing to the success of the Project, include the Darwin Naval Base Patrol Boat Facilities Project, and the HMAS CAIRNS Redevelopment Project.

Audit Approach

7. The audit was undertaken during the initial build stage of the first ship, when less than 10 per cent of total acquisition costs had been expended. The objective of the audit was to provide an independent assurance of the effectiveness of Defence’s management of the acquisition, and future provision of the ACPB capability, relating to the in-service support contract, provision of infrastructure, and crewing sustainability.

8. The final Safety Case Report⁶ had not yet been delivered to Defence at the completion of field work, and so was outside the scope of this audit. The audit also did not address the ability of the delivered ACPBs to meet the requirements of their intended operational employment, as the trials period, and 21 day mission trial associated with the acceptance of the First of Class (FOC) was not completed at the completion of field work.

Overall audit conclusions

9. The ANAO found that the contractual construct employed by the Defence Materiel Organisation (DMO) is a sound approach that will encourage the Contractor to deliver reliable, fully capable ships for use by the RAN. The DMO has sought to allocate significant risks associated with cost, and meeting a delivery schedule, to the Contractor, by rewarding timely delivery with a milestone payment regime, and discouraging schedule slippage by the capacity to invoke liquidated damages for delays against agreed ship delivery dates. The Project had met all contractual milestone payment dates as of August 2004.

10. The Project has adopted a whole-of-life, capability life cycle approach, which will maximise partnering benefits with the Contractor over the contracted life-of-type of the capability. The ANAO found that, to mitigate the risks associated with performance over the period of the Contract, the Contractor is responsible for delivering the training of crew, non operational maintenance, and general upkeep of the vessels, against a fixed cost, performance based contract. The payment to the Contractor for ship availability is at risk in the event that system failures, or platform non-availability, prevent the RAN from undertaking prescribed, operational activities.

11. The ANAO considers that Defence’s acquisition processes could have been made more effective by ensuring that:

• • capability documents were fully implemented, and approved, prior to awarding an acquisition contract;
• • Government Furnished Equipment (GFE), procured separately to the prime contract, is supported by a comprehensive analysis that accurately defines the through life costs; and
• • complementary Defence Corporate Services and Infrastructure Group (CSIG) facilities projects are programmed, prioritised, and co-ordinated, to deliver capability in a timely fashion, to support the requirements of the capability being delivered by the DMO.

Key Findings

Capability and Approval Processes (Chapter 2)

12. Defence requested that each tenderer for the new capability specified two financial solutions to provide the capability. The first solution was to be a PFI solution, based on the concept of providing patrol boats under lease to Defence. The alternate solution was to be the traditional direct purchase, with a follow-on support contract solution.

13. The structure of the PFI was considered not to involve the allocation of sufficient risk that would permit it to be classified as an operating lease.⁷ On subsequent advice from Government, Defence adopted a direct purchase option, in lieu of a PFI solution, for the replacement capability.

Build and Support Contract (Chapter 3)

14. Prior to issuing a Request For Tender (RFT), Defence were required to fully develop a Concept of Operations, which translates to an Operational Concept Document (OCD)⁸, and then a Functional Performance Specification (FPS)⁹, which in turn addresses the total capability requirements. The FPS usually translates into a Mission System Specification, and a Support System Specification. Defence then develops a Test Concept Document (TCD) that describes the measures of effectiveness associated with each individual functional performance specification. The ANAO found that the TCD was not developed prior to the award of the Contract.¹⁰

15. The Project stipulated the contractual deliverables via the Ship and Support specification documents, in the absence of an endorsed TCD. This could increase the risk that the resulting contract may not specify the required outcomes in sufficient detail to demonstrate that the delivered vessels are able to meet the desired Naval capability.

16. The acquisition element of the Prime Contract was initially structured to deliver capability against 108 individual milestones, for which payment is awarded. Support payments for the service related element of the contract will not be made until delivery, and acceptance, of the first delivered patrol boat by the DMO from the Contractor.

17. Following a competitive tender, Defence chose a TYPHOON 25 mm main armament system, at a cost of $8 million instead of the $30 million in the design specification. Defence chose the Cannon to be installed to the system in an effort to maximise commonality across Defence. The Cannon is similar, in many respects, to that used in the Bushmaster 25 mm system, installed on the Army’s Australian Light Armoured Vehicles (ASLAVs). The choice of calibre was undertaken on a cost-benefit basis, and represents value for money for Defence. The projected savings associated with choosing a 25 mm calibre round, over a 30 mm calibre round, while providing a similar capability, was estimated to be $11 million in through-life ammunition costs.

18. The ANAO found that a RAN safety case for the introduction of the main armament system had not been undertaken prior to choosing the main armament system, and prior to contracting for its delivery. The ANAO notes that there was a pre-existing safety case developed for a United States Navy platform, and that the decision to procure the gun system was based on that assessment. At the time of audit fieldwork completion, the system, although in contract for delivery, had not been proved to be acceptable for use, without modification.¹¹

19. The electronic radar surveillance system chosen for the ACPB capability was sole sourced at a cost of $13 million. The PRISM III system was selected primarily because it is already in service with the RAN’s Mine Hunter Coastal vessels. The ANAO found that the system required for the ACPBs is not the same as that already deployed. Obsolescence development work of $1.0 million is required to ensure the system on the Mine Hunter Coastal Vessels can be adapted for use with the ACPB capability. The ANAO also found that the in-service support costs for the PRISM III systems were not comprehensively evaluated prior to purchasing the equipment.₁₂

20. The ANAO found that the DMO had not applied standard audit access clauses to the sole source contract associated with procuring the PRISM III radar detection equipment. Defence investigated the costs associated with delivering the updated PRISM III capability. However, the ANAO did not have direct access to information held by the relevant contractor, and third party sub-contractors, and was unable to verify the work undertaken by the cost investigators.

Project Management (Chapter 4)

21. The ANAO found that the Maritime Technical Regulatory Materiel Requirements Set Specifications underpinning the Naval Technical Regulatory System¹³, which are used by projects to develop functional performance specifications, were not fully populated at the time of Contract signature.

22. The ANAO was advised by Defence that the Ship Specification, endorsed through the Chief Naval Engineer approval process, and defined by the Contract for the delivery of the Patrol Boats, was used as the Certification Basis.¹⁴ The ANAO notes that the Project Certification Plan was conditionally endorsed by the Chief Naval Engineer in September 2004¹⁵, eight and a half months after Contract signature.

23. The ANAO found that the TEMP had not been approved prior to Second Pass Government Approval in December 2003. The task of developing build specifications is made more difficult in the absence of the specified measures of effectiveness, against which the ships will be assessed for delivery, and acceptance.

24. In an effort to remain on schedule, the Contractor, and the Ship Builder, are required to make design decisions at commercial risk, and are reliant on the DMO to assess proposed design changes against Naval Regulatory Requirements.

25. The ANAO found that Defence access to the Ship Builder’s build and design information would be strengthened, in the unlikely case of corporate failure, by the introduction of escrow arrangements to ensure the retention of the documentation supporting the design and build of the ACPBs. The ANAO considers that the DMO would be well served by a post delivery audit of the full Intellectual Property (IP) arrangements.¹⁶

26. The absence of detailed Earned Value Management (EVM), or cost schedule control data, precluded the ANAO from fully assessing the real progress of the build program. In the absence of EVM data, the ANAO used the estimated data, provided by the Contractor to the DMO, to assess that the rate of effort required to complete the FOC prior to the scheduled trials period. The ANAO found that Defence would have benefited from an enhanced ability to oversight the project progress, as well as being better able to plan for delivery of GFE, and other Defence resources, had it been afforded access to the Ship Builder’s EVM system.

Delivery Management (Chapter 5)

27. The successful deployment of the new ACPB capability will largely depend on upgrades required to the existing facilities in Darwin, and Cairns. The upgrade proposed for the Darwin Naval Base is being undertaken as a separate project, at a proposed cost of $21.6 million. The Darwin Naval Base Patrol Boat Project received Public Works Committee approval in July 2004, to develop the wharf and engineering services package of the Darwin Naval Base Patrol Boat Facilities Project, at a cost of $5.53 million. The ANAO found that the proposal for an upgrade to the lift facility used to relocate Patrol Boats to a hard stand ashore (the Synchrolift), has not been approved, despite the cyclonic risk exposure of the Darwin region.¹⁷

28. The HMAS CAIRNS Redevelopment Project has been approved at a cost of $65 million. This will provide for upgraded support infrastructure at HMAS CAIRNS in preparation for the introduction into service of the new ACPB capability. Expenditure has been earmarked to commence in 2005–06. The capital development work specifically attributable to the ACPB capability is estimated by Defence to account for $10.44 million; and is to be provided in addition to the existing $65 million budget, courtesy of the ACPB Project. The ability to satisfy the operational requirements associated with the delivery of the ACPB capability in Cairns hinges on the selection of suitable wharf space to meet the introduction of the new class to HMAS CAIRNS, commencing October 2006.

29. The in-service support Contract facilitates the continuing transfer of detailed, deep level maintenance skills from contracted maintainers to operational Defence staff, by providing the ability for Defence to choose to second up to 30 Defence staff to the Contractor, at all times, at no extra cost, during the 15 year support period for each ACPB. The ANAO found that this innovative method of knowledge transfer will serve to assist the RAN in its aim to remain an informed operator, capable of maintaining the ACPBs under operational conditions at sea.

30. The ANAO found that Defence is proactively seeking to assess and monitor the characteristics associated with operating a ship constructed wholly of aluminium. The Patrol Boat Force Element Group (PBFEG) has sought to involve the Defence Science and Technology Organisation (DSTO) in an effort to design a methodology to monitor hull fatigue, corrosion, and subsequent cracking of the vessels as they age. Defence advised the ANAO that an industry alliance is being developed between DSTO and the Ship Builder to cover a number of areas of research and development that are of mutual interest.

31. The support phase of the contract between Defence and the Contractor is structured to utilise an abatement point system¹⁸, whereby the Contractor may accumulate abatement points for defects associated with the performance and non-availability of the delivered ACPBs. Once a critical number of abatement points have been accumulated within any one calendar year quarter, contracted payments are withheld, in accordance with a pre-agreed schedule. The ANAO found that the contractual arrangements may provide appropriate incentives for the build process to deliver a cost-effective and reliable Patrol Boat capability, under a combined build and service delivery construct. The ANAO notes that the abatement points management system does not necessarily guarantee the repair, in any one operational reporting period, of those defects that may be important to Defence capability.¹⁹

Recommendations

32. The ANAO made three recommendations directed at strengthening Defence’s project management and whole of capability delivery and in-service support processes. Agency Responses

33. Defence agreed with all the recommendations.

34. Finance agreed with all the recommendations. Finance advised the ANAO in its response to the audit that:

The Armidale Class Patrol Boat project had commenced development prior to the completion of the Review of Defence Procurement and the Government’s subsequent endorsement of the key recommendations. I note as a result, a more transparent process of documentation and earlier commitments from supporting areas in Defence, such as the Corporate Support and Infrastructure Group over facilities, would be required were the project to be developed now.

Footnotes

1 The Project budget includes the costs of: the Prime Contract; the provision of Government Furnished Equipment (GFE); infrastructure facilities for the new Patrol Boats; and project management.

2 Defence Maritime Services Pty. Ltd. (DMS) is a wholly owned by P&O Maritime Services, and SERCO, and is a Defence specific service company.

3 In addition to the crews, the RAN will provide victualling, fuel, ammunition and small arms outfits, RAN publications, medical supplies, access to maintenance facilities, and up to 30 RAN personnel for employment within the Contractorʼs maintenance organisation. The RAN will also provide RAN specific training.

4 Det Norske Veritas (DNV) is the classification society used for the build program.

5 The ACPBs are also being built, and are intended to be maintained, to Australian Maritime Safety Authority (AMSA), International Maritime Organisation (IMO), Safety of Life at Sea (SOLAS), and Maritime Pollution (MARPOL) specifications.

6 The Safety Case report for new systems and vessels is developed to certify that the system is safe to operate in a defined manner. The Director General of Navy Certification, Safety and Acceptance is responsible for accepting the safety case for maritime systems.

7 An operating lease would have allowed Defence to amortise the payments for the capability over the Contractʼs life for Commonwealth budgetary presentation purposes.

8 The OCD is used to: describe the characteristics of the required capability from an operational perspective; facilitate an understanding of the overall system goals for both the mission system and support system; detail missions and scenarios associated with operations and support; and provide a reference for determining ʻfitness for purposeʼ.

9 The FPS specifies the requirements for the system and provides the basis for design and qualification testing of the system. Defence guidance states that initial versions of the FPS should address the total system capability, which will later be developed into a mission system specification, and a support system specification, usually by the prime contractor.

10 The TCD is developed by identifying the Critical Operational Issues (COIs) indicated in the OCD. The agreed COIs are to be satisfied through the process of test and evaluation, and the agreed operational scenarios successfully trialed to accept the delivered capability, prior to full operational release.

11 Defence advised the ANAO in February 2005 that: ʻthe weapon system safety was assessed prior to the selection as much as was practically possible based on its proven use in service elsewhere and the Safety Study conducted for US Navy. A final safety case, reflecting the installation design on the Armidale Class vessel, is nearing completion for review and endorsement by the relevant Naval Technical Regulatory Authority, Director Navy Weapons Systems.ʼ

12 BAE Systems advised the ANAO in January 2005 that: ʻthe PRISM III system proposed for the Armidale Class is functionally identical in performance to the PRISM system installed on the Mine Hunter Coastal Vessel program but includes a small amount of non-recurring engineering required for minor interface differences between the Armidale Class and Mine Hunter Class platforms.ʼ

13 The Naval Technical Regulations Manual states that prior to Second Pass Government approval, the identified need for a new capability is subject to requirements analysis and functional analysis to better define the capability required, especially the functions it is to perform, the level of performance required, and the conditions under which this is to be achieved. Technical Regulatory requirements are also incorporated, including how they will be measured and certified through the Platform Specification,
Certification Basis, and Test and Evaluation Master Plan (TEMP). The TEMP includes design, production, and operational test and evaluation.

14 The Certification Basis constitutes the suite of standards against which materiel is to be certified, derived from, or judged to be equivalent to, a subset of the materiel standards, approved by the Technical Regulatory Authority.

15 The stated purpose of the Certification Plan is to define the Navy certification process required to facilitate initial, final and in-service certification for the ACPBs.

16 Defence advised the ANAO in February 2005 that it is their intention to periodically undertake post delivery audits as recommended.

17 The existing lift facility takes FCPBs from the harbour, and lifts them onto railway tracks for stowage on a hard stand ashore during maintenance periods, and periods during which Darwin is threatened by cyclones. The lift facility was installed after Cyclone Tracey damaged four of the Attack Class Patrol Boats in 1974. The lift facility is not capable of receiving the new ACPBs bow first without substantial upgrade modification. The bow first lift method is, for safety reasons, the preferred method of lifting ships in anything other than calm weather.

18 Abatement points represent a cumulative tally of contractual failures to meet operational requirements for the provision of capability by DMS to the RAN following delivery, and Interim Operational Release (IOR) of ACPBs. Abatement points are applied if the Contractor: is issued, and receives a Request for Support from a deployed ship; does not make an ACPB available for use by the RAN as programmed in the Fleet Activity Schedule; or does not provide surge availability in reply to a valid request for surge availability.

19 Defence advised the ANAO in February 2005 that: ʻthe risk of repair not being effected is expected to be minimised with critical mission essential defects having higher abatement.’