Expenses of and Funding for the Strategic Capability Projects of the Finnish Defence Forces
(Source: Finnish National Audit Office, VTV; issued June 17, 2020)
Finland’s two major weapon programs, the HX fighter and the Squadron 2020 corvettes, are being run on the basis of financial estimates that have been exceeded, the National Audit Office reports, adding that “estimated total costs could be more transparent.” (FIN MoD image)
The HX Fighter and Squadron 2020 projects of the Finnish Defence Forces have been prepared thoroughly. However, the estimated total costs could be more transparent.
The aim of the HX Fighter and Squadron 2020 projects is to replace and develop the Air Force and Navy capabilities to be phased out after the mid-2020s. Squadron 2020 has progressed to a phase where the shipbuilding contract and other key procurement decisions have already been made, whereas the HX Fighter project has not yet reached the final tendering phase (Best and Final Offer) and decision-making.
The purpose of the audit is to provide information on the long-term cost impacts and risks of these projects to support the related decision-making. The audit examined how the lifecycle costs and the prerequisites for implementation have been ensured in the preparatory phase. In addition, the audit assessed the impact of the HX project on compliance with the EU and national fiscal rules.
The projects are significant for central government finances. In the Government’s Defence Report for 2017, the value of the HX procurement was estimated to be EUR 7–10 billion. The annual operating and maintenance costs are based on the annual costs of the present Hornet fleet.
In October 2019, before the Revised Request for Quotation was issued, the Ministerial Committee on Economic Policy specified the procurement budget to be EUR 10 billion. At the same time, the operating and maintenance costs were capped at 10 per cent of the annual military defence expenses. At the cost level of 2020, this would mean a maximum of EUR 270 million per year.
When the estimated EUR 2 billion mid-life upgrades are added to the lifecycle costs, the lifecycle costs can total about EUR 20 billion at the price level of 2020.
The decision-making model and selection criteria of the HX Fighter project aim at maximizing the capability to be procured. The other areas in the decision-making model – security of supply, industrial cooperation, and lifecycle costs – are assessed as pass/fail. However, the different areas are not separate from each other but form a highly interconnected entity. Decisions taken in the area of security of supply or industrial cooperation have always an impact on the lifecycle costs of the system as well.
Information related to the lifecycle costs is specified only in the final tenders and may remain uncertain even thereafter. This poses a challenge for the preparations and decision-making. Parliament should decide on the funding for the HX procurement when discussing the budget for 2021. The actual procurement decision will be made by the Government on a proposal by the Ministry of Defence. This is expected to take place by the end of 2021.
As the costs of the HX procurement are significant, it has an impact on compliance with fiscal rules. Because of the rules linked with the National Accounts, the HX procurement will have a minor impact on compliance with the rules already during this parliamentary term. However, a greater impact will be seen when the fighter deliveries begin, which is expected to take place in 2025.
The general escape clause in the EU fiscal rules was activated in spring 2020 because of the economic impacts of the coronavirus. The escape clause allows the rules of the Stability and Growth Pact to be deviated from for the time being.
In the Squadron 2020 project, the Finnish Defence Forces are responsible for the management and coordination of the entity consisting of partial deliveries. The cost estimate committed to in the procurement decision was about EUR 100 million higher than the original budget. The total costs of the project do not include all separately purchased subsystems, which is not transparent. The total lifecycle costs of the Squadron 2020 procurement are estimated to amount to about EUR 3 billion in total. The procurement contracts made have strived to prepare for the identified risks in advance.
Both of the two strategic capability projects have been prepared thoroughly, and the preparations have also included external quality assurance.
The actual audit report will be kept secret with the exception of chapter 4 (Restricted, Act on the Openness of Government Activities 621/1999, section 24, subsection 1, items 10 and 17).
(EDITOR’S NOTE: By reporting that the Finnish Ministry of Defense has estimated the total life-cycle cost of the new HX combat aircraft at €20 billion (at 2020 prices), Finland’s Court of Audit is implying that the estimated budget is unlikely to be sufficient.
Lifetime operating costs are generally considered to be twice the cost of procurement, which Finland has estimated at €10 billion for whichever aircraft wins the ongoing competition.
Yet, the total lifecycle cost estimate used for budgeting purposes is €20 billion, or just double the procurement cost.
This implies a shortfall of about €10 billion over the program’s lifetime when compared to the generally-accepted benchmark.
Furthermore, each of the competing aircraft has widely different operating costs – for example, flight hour costs vary from $44,000 for the F-35 to less than $20,000 for Gripen – making it improbable that the €10 billion earmarked for operating costs will be enough to cover the operating costs of all competing aircraft.)
Valuable Feedback from the State Audit Office
(Source: H-X Program Director Lauri Puranen; posted June 17, 2020)
(Unofficial translation by Defense-Aerospace.com)
Projects the size of strategic projects are seldom prepared. Although they are prepared according to Finnish legislation and standards, as are smaller projects, projects of this scale have their own special features, challenges and responsibilities.
I will not go into more detail on the procurement models for HX or Squadron 2020 projects here, but I note that both have sought to ensure that the funding allocated to the projects maximizes the performance of the Finnish defense system. In practice, this has led to the construction of very ambitious and complex but also functional entities from the procurement models of both projects.
Strategic projects must be of high quality and must undergo critical discussion and external review. Although our own expertise has been used a lot, we have not hesitated to obtain outside support. External quality assurance has supported both projects, and we have also obtained some other support, including contract law for the projects.
Today, the main conclusions and parts of the audit of the State Audit Office, which has focused on the preparation of strategic projects, were published. The aim of the audit has been to provide information as a basis for decision-making, especially on the long-term cost effects and risks of projects. The VTV report is valuable feedback to our draftsmen and we welcome its recommendations.
For the HX project, VTV's audit is excellent in timing. All of VTV's recommendations can be taken into account in the most important stages of the project, ie in the preparation of the final call for tenders, the evaluation of the final tenders and the preparation of the procurement decision.
With regard to the Squadron 2020 project, VTV's audit confirms that the project has been carefully prepared and that decision-makers have also been provided with sufficient information about potential risks. A link to the inspection report can be found at the foot of the end of my blog.
VTV states: “The preparation of the HX and Squadron 2020 projects has been thorough. However, the transparency of the estimated total cost of the projects could be better. " I will now open the background to this observation from a project perspective, but before that, one terminological clarification: the total cost or life cycle cost covers all the costs of the system, i.e. it is the sum of the acquisition price and the operating and maintenance costs.
The total costs of both projects are carefully monitored, as Finland cannot buy a weapons system that cannot be used.
From the outset, it was clear that some of the Ostrobothnian-grade armaments (anti-ship missile, torpedo) would be more widely used by the navy and would be procured other than through the main contracts of the Squadron 2020 project. Although these performances do not, from a budgetary point of view, come from the same funding as ships and combat systems, operating and maintenance costs have been taken into account in the planning for the coming years. In this respect, however, transparency could be clearer.
The operating and maintenance costs of the HX project have been discussed really lively recently. At least I do not remember that the life-cycle costs of any other public procurement would be discussed as critically as the costs of HX procurement.
The policy given to the defense administration regarding the operating and maintenance costs of the HX system is completely unambiguous: the operating and maintenance costs will not receive additional funding and will not exceed 10% of the annual defense budget. The cost of the new system must therefore be of the same order of magnitude as the current system, so it is worth putting an end to the total cost of EUR 30-40 billion.
Calculated in terms of the value of money in 2020 and the defense budget, the use of the HX system will cost a maximum of EUR 250 million per year until the beginning of the 2060s, when that ten per cent is used as the basis for the calculation. In addition, two major lifecycle upgrades are planned for the system, estimated to cost around € 1 billion each. Thus, the 30-year operation and maintenance costs will be less than € 10 billion - part of the annual defense budget - and the total cost of the HX system will be less than € 20 billion.
Why we do not even present exact figures to decision-makers at this stage is another matter. In the middle of the project negotiation process, it is premature to take a position on the operating and maintenance costs of individual candidates. Nor do we present to decision-makers unfinished performance solutions or possible industrial cooperation solutions, of course, an overview of these decision areas is also provided.
We also cannot provide information to the public while the competition is in progress. Opening the information to the public could affect not only the Finnish project, but also the bidders' competitive position in fighter procurement in other countries. In addition, some of the information is business and professional secrets of companies and we have a duty of confidentiality with respect to it.
There is still time and every provider is building a solution that meets Finnish requirements. Only when each provider as a whole is complete can its military performance, final cost, domestic employment impact, and acceptability of the security of supply solution offered be assessed.
Click here for the full report (8 PDF pages, in Finnish), on the VTV website.