HC Deb 26 February 1968 vol 759 cc947-53
The Chief Secretary to the Treasury (Mr. John Diamond)

The Government have reached agreement with industry on new arrangements for placing and pricing the non-competitive Government contracts covered by the existing profit formula. These arrangements will take effect immediately.

The then Minister of Aviation informed the House on 2nd March, 1966, that the Government were discussing with industry the need to secure a contractual right to equality of information and post costing. He also announced that the Government were inviting comments from industry, which had pressed for a review, on the profit formula used in these contracts.

Discussions on these two issues have been detailed and prolonged. They have proceeded in parallel, but the Government have made it clear that there can be no question of paying a price for the equality of information which the Second Lang Report recommended for the fixing of fair and reasonable prices. To achieve genuine equality the Government has also insisted on the right to post-cost individual contracts. Industry has acquiesced in the use of new contractual conditions which meet the Government's essential requirements.

The Government and industry have agreed that the aim of the formula should be to give contractors a fair return on capital employed; that is to say equal on average to the overall return earned by British industry in recent years.

The yardstick will be the average of industry's earnings over the last seven years for which figures are available—1960–66. This gives a figure of 14 per cent. on capital employed.

Given the complex accounting issues involved there will be further urgent discussions with industry on the rates to be applied to achieve this aim.

The Government recognises the importance of fair profits for their contractors, and mean to ensure that outstanding efficiency should be rewarded. This can be done by agreeing a fixed price (which limits the Government's financial liabilities) at an early stage. This gives the contractor a strong incentive to increase his profits by improving his efficiency. Alternatively, target prices can be agreed with suitable profit-sharing provisions in appropriate cases.

The Government accept the view of the Second Lang Report that fixed prices freely negotiated should in general not be retrospectively modified. The main uses of post-costing would therefore be not to renegotiate prices, but to price follow-on orders, to check the accuracy of cost estimates and to provide necessary cost information. This should improve the quality of estimates and reduce the weight on Government Departments.

Nevertheless, arrangements must be made to deal with excessive profits, given that there is no competitive check on the agreed prices. With equality of information and post-costing the risk is substantially diminished, but selective post-costing may still indicate cases where excessive profits may have been earned. The basic issue will be whether the original price was fair and reasonable, and whether the profit was fairly earned by outstanding efficiency.

Agreement has been reached on a proposal to set up an impartial Review Board, and to secure acceptance of its rulings by a new contractual condition. Both sides could refer contracts where profits of 27½ per cent. or more on capital employed and losses of 15 per cent. or more had been made, to establish whether any reimbursement, or compensation, was justified. In exceptional cases, the Board might review contracts referred to it by either side within these percentages where there was evidence that prices had not been fair and reasonable. In addition to reviewing individual contracts and giving rulings which both sides would agree in advance to accept, the Review Board would also be given the task of collating the evidence for a review of average earnings on contracts. For this purpose the Review Board would act in an advisory capacity. A review after three years, which could relate actual earnings on this work to the latest trends in overall average earnings of British industry, would be in the interests of both sides.

Mr. Higgins

As the Chief Secretary has said, these are highly complex accounting issues. Might I ask him to clarify three points? First, with regard to the figure of 14 per cent. which he gave, apparently as the level of rate of return of capital which the Government would expect firms undertaking these contracts to achieve, has that figure been calculated on a historic-cost basis for measuring capital or a replacement-cost basis, or a mixture of the two? Secondly, are we right in supposing that this is effectively the ex-post rate of return they expect to achieve so that the rates which are included in the contract would therefore be somewhat different—I would presume somewhat higher than these figures—which would give industry a basis for making investment decisions?

Thirdly, does the statement truly reflect the view expressed by the Lang Report, which was that it accepted the view that fixed-price contracts should not in general be retrospectively modified, but on the pure facts of the case, was not the final recommendation of the Lang Report that it would deprecate the idea of the Ministry having a general right to post-cost fixed price contracts?

Mr. Diamond

The answer to the first question is that the 14 per cent. is based on historic cost. The answer to the second question is that the rates in the respective contracts for cost-plus and noncompetitive risk contracts would be such as to secure, all told, the target over a period, of the 14 per cent. in commercial terms, to which I have just referred. With regard to the third question, the Lang Report, as the hon. Gentleman suggests, did not recommend post-costing. In paragraph 5(36) it says: We would deprecate the introduction of post-costing into Ministry of Aviation fixed price contracts…. It went on to indicate circumstances in which it might be necessary to refer to post-costing. In the view of the Government, one cannot have genuine equality of information without post-costing.

Mr. Mikardo

May I ask my right hon. Friend two questions? First, does not he think that the two figures of 27½ per cent. profit and 15 per cent. loss are too high even allowing for the reservation that in some cases the matter may be investigated even if the figures are lower? Secondly, is it not obvious from his statement and from the questions of the hon. Member for Worthing (Mr. Higgins) and my right hon. Friend's answers that these matters are much too complex to be dealt with by question and answer? Therefore, would my right hon. Friend ask the Leader of the House to arrange a debate on this very important matter?

Mr. Diamond

I will arrange to have the attention of my right hon. Friend drawn to my hon. Friend's comments. With regard to the figures mentioned, this is a trigger mechanism, nothing more, as I am sure my hon. Friend appreciates. These are merely outside figures—either of extreme profit or of extreme loss in terms of return on capital—which if reached could compel a reference to the Review Board. Figures within that range might result in a reference to the Review Board. But I think that my hon. Friend would agree that one does not want to go into unnecessary detail when profits are within a reasonable band.

Mr. Boyd-Carpenter

Does the right hon. Gentleman's statement mean that in future, as in the past, the acceptable rate of profit on a non-competitive Government contract will differ as between risk and non-risk contracts? Secondly, can he say whether the obligation under Standard Condition 43 to agree a fair and reasonable price will in future be laid down as relating solely to the particular contract of which it is a clause and not to the general relations between any particular firm and any particular department?

Mr. Diamond

The right hon. Gentleman is right in suggesting that there will be the distinction in future as before between risk contracts and non-risk contracts, both of the non-competitive variety. The "fair and reasonable" clause in the conditions applies to that particular contract.

Mr. Sheldon

In congratulating my right hon. Friend on his efforts to obtain equality of information and post-costing, may I ask him whether he can say if this will apply to present contracts already being carried out and also to those contracts already terminated but for which payment has not yet been made?

Mr. Diamond

No. With regard to contracts entered into but which are not complete in the sense that the price has not been fixed, it would not be right to compel, indeed it would not be possible to compel, a change in the contract terms. But when the contract is not complete in the sense that the price has not yet been fixed, it will be open to the contractor to opt for the new profit formula if he wishes to incorporate it in his contractual terms.

Mr. Lubbock

Is the Chief Secretary aware that everybody will welcome the agreement reached between the Government and industry in this matter and only regret that it has taken two years to achieve? Would he agree that it is very important, if we are to get the maximum incentive effect from fixed price contracts, to agree the fixed price as early as possible in the progress of the contract?

Mr. Diamond

It is agreed on all sides that an essential condition of securing efficiency and good relationships is to get the terms agreed as soon as possible, but, as the hon. Gentleman knows, in certain cases the complexities are such that "as soon as possible "is bound to take a little time. It has taken some time to reach agreement. The hon. Gentleman knows that it takes two people to reach agreement.

Mr. Cronin

While I welcome my right hon. Friend's efforts to avoid excess profits, is he aware that it is rather disappointing that there are not direct financial incentives for increased efficiency on the part of contracting firms such as those practised by the United States Department of Defence?

Mr. Diamond

With respect, I think that there are direct incentives to increase efficiency, because once the price has been fixed, provided it has been fixed on a fair and reasonable basis and on the terms of full equality of information, there is every incentive for the contractor to improve his efficiency in production by every possible means and gain the profit which arises from that increased efficiency.

Sir A. V. Harvey

In the past, one of the weaknesses has been the insufficiency of Government cost accountants to deal with their side of the work which has led to delays and inefficiency. Is the right hon. Gentleman prepared to use outside help, either accountants or cost accountants, to speed up the work and to get early decisions and efficiency?

Mr. Diamond

That is a different question which I should have to consider very carefully in relation to the general request that public expenditure should be kept down. I realise that a number of elements come into that.

Mr. Dalyell

As a member of the Public Accounts Committee at the time of the Lang Report, I should like to express a very favourable reaction to my right hon. Friend's statement. May I ask him two questions? First, what are the functions of the impartial review body? Secondly, is he sure that these present measures do not make even more complex and difficult the job of the Inland Revenue?

Mr. Diamond

I can say "Yes" immediately to my hon. Friend's second question. I am grateful for his introductory remarks. The functions of the review body would be twofold. The first would be to decide whether in cases submitted under the trigger mechanism to which I referred an additional payment should be made by the Government to the contractor or whether a refund should be made by the contractor to the Government having regard to the degree of profit or loss made and all the relevant circumstances which surrounded the contract. That would be a compulsory decision binding on the parties to the contract. The other function would be to review in three years the overall profit made by industry on Government contracts. We have not yet been able to get information of that kind, and it is necessary for goodwill in future.

Sir G. Nabarro

Whereas a 14 per cent. return to a contractor is not ungenerous with most contracts, would not the right hon. Gentleman agree that the nub of this matter is that non-competitive tendering, which amounts to cost-plus, should be reduced to an absolute minimum and that competitive tendering should always be enforced by the Government wherever practicable?

Mr. Diamond

Yes. I recognise that cost-plus tendering should be reduced to a minimum, but there are a number of contracts which are not of a competitive nature which, nevertheless, are not cost-plus, and it is those contracts in particular to which I am referring. All told, I think that there is about £600 million worth of contracts a year let on a non-competitive basis, of which about £200 million are cost-plus and £400 million are non-competitive risk contracts.

Several Hon. Members rose—

Mr. Speaker

Order. We must move on. We have a lot of work ahead of us.