The objective of the audit was to report on the progress of the current phase of the AWD Program, which is known as SEA 4000 Phase 3–Build. This phase commenced in June 2007, and covers the finalisation of the detailed design, the signing of the Alliance and Platform System Design contracts, and the construction and delivery of the ships by the Industry Participants to the DMO.
Phase 2 of the AWD Program was the design phase, and ended in June 2007. Phase 2 is addressed in this report in terms of its role in reducing risks in Phase 3.
The audit focused primarily on Defence’s administration of the AWD Program. It examined Defence’s progress thus far in establishing and working through the management structures and processes used to deliver the DDGs within approved cost, schedule and performance parameters. The audit considered the Hobart-class DDGs’ design and construction in terms of: the achievement of key engineering and construction milestones, based on systems engineering criteria; the management of cost, schedule and their attendant risks; and the effectiveness of the Alliance contract.
The high-level criteria used in the audit to assess Defence’s administration were as follows:
- contract management processes should be in accordance with internal Defence procedures and contractual provisions;
- appropriate project governance, financial controls, and reporting mechanisms should be in place;
- delivery and acceptance arrangements should assure conformance with technical regulatory requirements; and
- the program should adhere to agreed systems engineering procedures.
At a budgeted cost of some $8.5 billion, the SEA 4000–Air Warfare Destroyer (AWD) Program is one of the largest acquisitions undertaken by the Department of Defence (Defence) for the Royal Australian Navy (RAN). The Program will deliver three Hobart-class Guided Missile Destroyers (DDGs) that will replace the RAN’s four remaining Adelaide-class Guided Missile Frigates (FFGs). The DDGs are based on a modified version of an existing design, newly exported by a Spanish designer to a new Australian shipbuilder for construction in a distributed-build environment. The Alliance contract for the construction of the DDGs involves the Commonwealth as the owner-participant; and two non-owner Industry Participants, namely ASC AWD Shipbuilder Pty Ltd, the subsidiary of a (Commonwealth) Government Business Enterprise (GBE) and Raytheon, a public company.
The AWD Program’s governance and construction arrangements are inherently complex, but seek to strike a reasonable balance between assigning core responsibilities to individual parties and promoting a cooperative relationship between the Alliance participants. The Alliance contract imposes a ‘fundamental obligation’ on the Industry Participants to deliver the DDGs and other Supplies and to achieve delivery schedule commitments. There is, accordingly, high dependency on the performance of the Industry Participants to manage the project risks in association with the Commonwealth. Any residual risks accrue to the Commonwealth in funding the project, and to the Commonwealth’s representative in the Alliance, the Defence Materiel Organisation (DMO), in managing the delivery of this significant capability within cost and to schedule, as the AWD Program manager and project customer on behalf of the RAN.
Successive Australian governments have accepted that building the DDGs in Australia would involve a premium over and above the cost of building them overseas. The decision to build locally is based on a desire to retain shipbuilding jobs and facilities, project management and design skills, and experience with sophisticated naval combat systems, so as to enable through-life support of the DDGs in Australia and a continuing naval shipbuilding industry. As part of the June 2007 Second Pass submission to government, the Treasury noted that the premium associated with building the DDGs in Australia was around $1 billion, representing an effective rate of assistance of over 30 per cent for naval shipbuilding.
Since the commencement of the build phase, the AWD Program has developed and maintained a skilled workforce and production facilities, and made significant progress in the construction of the DDGs. As at January 2014, consolidation of blocks in the form of a hull was nearing completion on Ship 1, and zone-level fit-out was well underway. The majority of Ship 2 blocks were structurally complete and production outfitting was underway. In the near future, the build phase will expand into the installation, set-to-work and systems integration of complex state-of-the-art warship platform and combat systems. Nevertheless, under current plans, there is a gap between the DDGs’ production and the next design-and-construction program for major surface ships, which would result in a reduction in the naval shipbuilding workforce. A range of Defence stakeholders have observed a risk, which is under consideration by the Australian Government, that the experience and knowledge gained by the shipbuilding sector during the build phase may not be available to meet the RAN’s future whole-of-life support and capability requirements.
Defence developed the AWD Program ship design options and alliance arrangements through a substantial investment in a competitive design phase and the close involvement of industry during that phase. This resulted in the selection of a modified Existing Design by the then Government in 2007 instead of an Evolved Design. The Evolved Design was considered to be too immature and presented high risk. In developing the Alliance contractual arrangement, Defence combined elements of a typical alliance contract with the more ‘standard’ risk allocation provisions of a fixed-price contract, with a view to protecting the Commonwealth’s interests. The Alliance contract obliges the Industry Participants to deliver the DDGs and meet schedule commitments. Based on the extensive work undertaken on the design by industry in the design phase, the Alliance contract also includes warranties by the Industry Participants that they had assessed the risks they were assuming; and that they had the resources required to perform their obligations.
Despite the contractual arrangements put in place to manage the project, the AWD Program has experienced a range of delivery issues, including significant immaturity in detailed design documentation, major block construction problems and substantially lower than anticipated construction productivity. The design and construction issues have led to extensive, time-consuming and costly rework.
The Alliance reported in November 2013 that the contract for the construction of the DDGs would be completed at an estimated cost of some $302 million or 6.8 per cent in excess of the Target Cost Estimate. The cost overrun is attributable to the shipbuilding elements of the project. As previously reported in the 2012–13 Major Projects Report, the AWD Program exceeded its original budget allocation for 2012–13 by $106.4 million as a result of increased Direct Project Costs from the Industry Participants for labour, materials and subcontract costs. In the same report, the CEO DMO advised that:
There are emerging concerns from the AWD Alliance around cost overruns and associated delays in shipbuilding aspects of the AWD Program. An independent review is to be commissioned to identify factors contributing to cost growth and delays, and to recommend remediations and mitigation.
In the light of these concerns about cost overruns, the current estimated cost of $302 million in excess of the Target Cost Estimate should be treated with caution; the cost increase is likely to be significantly greater.
The delivery schedule for the three DDGs was revised in September 2012 and is now some 15 to 21 months later than the original delivery schedule (for Ships 1 to 3). Despite the effect of design and construction issues on the cost and schedule for the DDGs, their materiel capability requirements remain as specified at Second Pass approval. However, Operational Test and Evaluation to validate the specified capability achievement is scheduled to commence in August 2015 for Ship 1, 12 months later than originally scheduled.
While Defence did seek to adopt prudent risk mitigation strategies in the design and build phases of the program, drawing heavily on industry input and experience to inform its advice to government, the risks of developing a modified design, exporting the design for construction in distributed Australian shipyards, and re-establishing Australia’s shipbuilding capability were underestimated. This is the first time the Spanish designer Navantia has exported a surface ship design for construction by international shipyards, the first time ASC has built a surface ship, and the other Australian shipyards lacked recent experience in complex warship building. While Defence has subsequently sought to address design, construction and productivity issues through DMO involvement in Alliance governance and program management, and the application by the Industry Participants of new strategies during the build phase, substantial performance issues were ongoing in late 2013. As mentioned above, the continuing detailed design, construction and productivity issues present a significant risk of further overruns in the cost of the project, as well as in the delivery schedule, and will require an ongoing management focus. Further, the program is approaching the complex stage of systems integration when, historically, cost and schedule risks tend to rise.