My Lords, Amendments 5 and 6 seek to bring out the relative weight given by the Bill to the contract profit rate and allowable costs. The contract profit rate is the subject of Clauses 17, 18 and 19; allowable costs are the subject of Clause 20. The split between profit and allowable costs is typically that more than 90% of the final price will be allowable costs and less than 10% will be profits.
Clause 17(1) states:
“Single source contract regulations must make provision for determining the contract profit rate for a qualifying defence contract”.
Since it is a regulation, it will be made by statutory instrument, with all the parliamentary attention that that will enjoy. Clause 20, which is about much, much more money—nine or 10 times as much money—simply says that the SSRO,
“must issue guidance about determining whether costs are allowable costs under qualifying defence contracts”.
The essence of our concern is that the real potential for profit and loss in a defence contract comes from how the allowable costs are set. They are the much bigger proportion, and once the deal is set—unless it is a profit-sharing contract such as we have just discussed, and even there, the allowable costs are set—every pound by which the contractor is able to produce the goods cheaper than the allowable cost converts to profit on their account. It may not be under the profit part of the pricing deal, but it drops to profit. One has to realise that a substantial amount of the allowable costs—sometimes more than half—are allocated overheads. If you are the finance director of this large conglomerate, you are probably more concerned about making sure that you can—I was about to use a very unparliamentary word—get as much of your overheads into the allowable cost as possible. If one were negotiating this deal, one would not worry about the profit; everybody knows that it is going to be about 10%, as it is laid out by statute and all that sort of thing. The concentration would be to get as much into the allowable costs as
possible, both in terms of the original price setting and in terms of taking advantage of some of the price adjustment mechanisms.
It is therefore our contention—and Amendments 5 and 6 give effect to this contention—that the allowable costs rules should be set out in regulations and that there should be a framework of regulations setting out the criteria for allowable costs, recognising that the actual detail of allowable costs will be extensive and that those criteria should go on, as Amendment 6 proposes, to be the subject of guidance from the SSRO. It is a very simple idea, but, we think, a very important one: to give the debate on the most important part of the price a higher profile in the public domain, and to try to persuade the Government that they should be as accountable—indeed, more accountable—for the criteria setting allowable costs as they are for those setting profit.
The Government will no doubt come back and point to Clause 20(2), which sets out criteria. I was somewhat scathing about the criteria in Committee, so I shall try to be less so now. The three criteria are that the cost should be,
“appropriate … attributable to the contract, and … reasonable in the circumstances”.
Working backwards through them, my general understanding of administrative law is that things have to be reasonable in the circumstances. I would not quibble at throwing “reasonable” into the Bill, but it is not a particularly heavy or precise definition.
The next criterion is “attributable to the contract”. It does not seem to me a very exciting idea that the cost should be attributable to the contract; I think that the average lay person would expect allowable costs to be attributable to the contract. Nevertheless, that is what is set down.
The only criterion that seems to have any substance is that the cost should be appropriate. I have a very low opinion of the word “appropriate”. I used to stand on the opposite side of this Chamber and read the stuff that the officials produced for me. Whenever I saw “appropriate”, I knew it meant that they could not find a better argument—I fear that that is what “appropriate” means.
The overarching framework of allowable costs should be set out in regulations so that they can come before Parliament and be widely developed. The SSRO’s guidance should be developed from those fundamentals and should be in the public domain. I beg to move.