Next Generation Fighter Capability Annual Update- December 2012

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Executive Summary

In the 2012 Spring Report, Replacing Canada’s Fighter Jets, the Auditor General identified concerns with the way key information was being developed and presented to Canadians and recommended that the Department of National Defence refine its estimates for complete costs related to the full life cycle of the F-35A.

The Government of Canada agreed with the Auditor General’s recommendation and launched a Seven-Point Plan to ensure that the Royal Canadian Air Force acquires the fighter aircraft it needs to complete the missions asked of it by the Government, and to do so through an open and transparent process.

The Seven-Point Plan calls on National Defence, through the National Fighter Procurement Secretariat, to provide annual updates to Parliament. This report is focused particularly on the cost of the F-35A. For this reporting period, the Secretariat recommended that this report be delayed until Fall to allow for an independent, third-party review of costs, including the development of a full life-cycle costing framework that draws on international best practices.

This Update provides revised cost estimates based on a Life-Cycle Cost Framework developed for National Defence by KPMG, an independent private sector consulting firm. These revised estimates, and the assumptions underlying them, were reviewed by KPMG. This report explains how and why the cost estimates differ from those previously reported. All future cost estimates for any CF-18 fighter replacement capability will be informed by this Framework.

For example, in 2010 the Department calculated that the cost of acquiring 65 F-35A aircraft was $9.0 billion. For decision-making purposes, the Department also calculated sustainment costs for 20 years at $6.6 billion ($5.7 billion for sustainment and $0.9 billion for contingency), and operating costs – which are funded from the Department’s annually approved budget – at $9.6 billion. Altogether, including contingency, the estimated cost for acquiring, sustaining and operating the fleet based on those figures was $25.1 billion.

National Defence’s application of the amended life-cycle cost methodology to the original 20-year period results in a revised estimate of approximately $25.8 billion. This is less than three per cent higher than the original National Defence cost estimate prepared in 2010. When $356 million in Memorandum of Understanding payments that National Defence identified in 2010 are included in the 2010 estimate the difference is less than one and a half percent. Table 9 in the comparative analysis on page 45 provides additional information.

Whereas National Defence’s 2010 cost estimate covered acquisition and 20-years of sustainment and operations after first aircraft delivery, this program life-cycle cost estimate covers the period beginning in 2010 with the Government’s announcement of its intention to acquire the F35 and ending 42 years later with the disposal of the last aircraft in 2052.

Once the longer period is applied, the new estimated cost for development, acquisition, sustainment and operating, and disposal of the fleet is $44.8 billion. The longer program life-cycle period of 42 years accounts for the vast majority of the cost increase over the originally reported estimate. The remaining changes result from more up-to-date costing information, refined planning assumptions, the addition of development and disposal costs, as well updated economic factors. Table 8 on page 44 and the accompanying text explain in more detail the changes in the estimates between 2010 and 2012.

 

COMPARATIVE ESTIMATE
$M BY ($ Million in Budget Years)
Cost Element

 

2010 Estimate (as presented in the Spring 2012 Auditor General Report, pg. 27)

 

2012 LCC Estimate (using the same time periodas the 2010 estimate)

 

2012 LCC Estimate (42-year ProgramLife Cycle Estimate)

Time Period

 

Acquisition plus 20 years of sustainment and operating costs fromdelivery of first aircraft

 

Development, acquisition plus 20 years of sustainment and operating costs from delivery of firstaircraft

 

Development, acquisition plus 30 years of sustainment and operating for each aircraft andincludes disposal

Development Not included 446 565
Acquisition

 

8,980

8,990 8,990
Sustainment

 

6,570

7,303 15,240
Operating

 

9,570

9,092 19,960
Disposal

 

n/a

n/a 65
Total

 

25,120

25,831 44,820
Attrition     982
Total     45,802

 

KPMG’s Life-Cycle Cost Framework is “principles-based,” and is not fully prescriptive. As a result, some choices had to be made about whether and how to apply those guidelines to the National Defence cost estimate. For example, an additional cost that is not included in the full life-cycle cost of $44.8 billion is the cost for the replacement of aircraft lost due to peace-time accidents.

It is estimated that seven to eleven aircraft could be lost over the 42-year timeframe and the cost to replace these lost aircraft could be in the order of $1 billion. Rather than initially acquiring more aircraft than are required, the Government has retained the option to purchase or not replacement aircraft in the future. Production of the F-35A is planned to continue until at least 2035.

The F-35A is still in development, and there is a high degree of uncertainty associated with variables such as exchange rates and inflation. Therefore the level of contingency set aside to manage the risk of unforecasted cost increases is important. The 42-year program life-cycle cost estimate in this report includes $602 million for acquisition contingency and $1.95 billion for sustainment contingency. While the total level of contingency falls within the recommended range in KPMG’s Framework, the acquisition contingency amount could still be considered low for a project of this scope and size. As a result, any option moving forward will be informed by the Government's $9 billion acquisition cap to acquire next generation fighter aircraft to replace the existing fleet of CF-18s.

The report Next Generation Fighter Capability: Independent Review of Life-Cycle Cost prepared by KPMG for the Treasury Board Secretariat of Canada found that the cost methodologies and assumptions used to develop the life-cycle cost estimate contained in this Annual Update are appropriate. Furthermore, the life-cycle cost estimate complies with the key principles of the framework contained in the KPMG report Next Generation Fighter Capability: Life-Cycle Cost Framework.

The KPMG report concludes that their independent review "… did not identify significant quantifiable differences in the Estimate resulting from DND's application of the Framework.” In addition to the overall conclusions, other findings and recommendations were noted. However, no significant quantifiable differences were noted as a result of these findings.

This report is divided into seven parts. Part I reviews briefly the observations and recommendations of the Auditor General, and sets out the reasons for the Annual Update. The next section, Part II, explains the three roles identified for the Canadian Armed Forces in the Canada First Defence Strategy: Canadian security and sovereignty, the defence of the North American continent, and international peace and security. This section also discusses the challenges facing the CF-18 fighter aircraft fleet and the importance of replacing it to ensure that the Canadian Armed Forces are able to continue to fulfill the roles identified in the Defence Strategy.

Part III provides insight into the methodology used for estimating the life-cycle costs of a new aircraft fleet. This section explains the uncertainties associated with life-cycle costing and the importance of understanding differences in terminology between Canada and the United States.

Part IV responds to the concerns of the Auditor General, the public and other stakeholders by reporting on the full life-cycle costs of a fleet of F-35A aircraft.

This section demonstrates how Canada’s participation in the various stages of the United States-led Joint Strike Fighter Program, established to develop the F-35A, has benefited this country in military and economic terms. It also shows how the cost information received from the Program provides National Defence with the statistical basis for estimating the cost of the F-35A option.

This section also provides current cost estimates based on the KPMG Framework, and spells out in considerable detail National Defence’s current planning assumptions with regard to development, acquisition, sustainment and operating costs for a fleet of 65 F-35A Joint Strike Fighters.

Part V covers the risks and uncertainties pertaining specifically to the life-cycle costs of the F-35A option and describes in detail a variety of risks—from foreign exchange fluctuations and inflation to possible increase in the cost of aircraft.

Part VI discusses program affordability, which decision-makers must take into account when evaluating options, and presents a table comparing estimated costs using a 20-year view and a 42-year program life cycle. Part VI also undertakes a comparative analysis and explains the changes from the cost estimate reflected in the Spring 2012 Auditor General Report to the current estimate.

Finally, Part VII contains concluding remarks, and commits National Defence to updating decision makers and Parliament on an annual basis. The KPMG

Life-Cycle Cost Framework will help to provide the basis on which National Defence continuously refines and publishes its life-cycle estimates and to prepare these annual updates on the replacement of the CF-18 fleet.

While this Update provides a comprehensive assessment of costs related to the F-35A, National Defence nonetheless continues to evaluate other options to sustain Canada’s fighter capability well into the 21st century. These alternatives will, of course, have their own costs that need to be compared to the F-35A option. Cost estimates for each option analyzed will be developed to the extent possible while respecting commercial sensitivities and informed by the independently developed Life-Cycle Cost Framework.

The Government will make a decision on a CF-18 replacement after the

Seven-Point Plan has been completed and the National Fighter ProcurementSecretariat Deputy Minister-Level Governance Committee has presented its conclusions to Ministers.

If you would like a copy of this report, please e-mail us at the following e-mail address: information@forces.gc.ca.

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