In the financial year to 31 March 2016, 67% (2015: 67%) of QinetiQ Group revenue was generated from the UK Ministry of Defence (MOD) in addition to 3% (2015: 3%) from other UK Government Departments. We are the UK’s leading provider of test and evaluation (T&E) services across all military domains and the majority of equipment programmes. We generate more than £300m per year from T&E, underpinned by the Long Term Partnering Agreement (LTPA), which has delivered an improved service and significant savings for the MOD over the last 13 years. We estimate the UK T&E market is double this size and the addressable market worldwide is much greater. Leading the UK T&E enterprise by working in partnership with Government and prime contractors is one of the key pillars of QinetiQ’s strategy. In addition, we remain a market leader in research and advice in specialist areas such as C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), weapons and energetics, cyber security and procurement advisory services.
Within the MOD, the main customers for our services are the MOD’s procurement function DE&S (Defence Equipment and Support), the Defence Science and Technology Laboratory (Dstl) and the Front Line Commands (Navy, Army, Air and Joint Forces), whose influence on future capabilities has increased in recent years. Our businesses are aligned closely to these Commands and are well placed to help them with their growing procurement responsibilities. In particular, Joint Forces Command, with its own procurement arm and multi-billion pound budget, provides a focused channel for our Cyber, Information & Training business.
The UK Government’s Strategic Defence and Security Review (SDSR) was published on 23 November 2015. Its publication has helped to clarify the UK’s capability priorities, but it will take time before its impact on the associated allocation of the UK defence budget is clear.
As part of the SDSR, the MOD has declared plans to address important capability gaps such as maritime surveillance (through the purchase of nine new aircraft) and combat air numbers (by extending the life of Typhoon aircraft that have been in service for some time). These plans will require immediate savings to be made elsewhere in the defence enterprise to fund them, with the UK Government looking to achieve a 30% reduction in MOD civilian staff and in ‘built’ estate to deliver £11bn of savings from defence and security budgets over the next four years.
The introduction of new capabilities, and in particular extending the life of existing capabilities, provides QinetiQ with opportunities to deliver engineering, test and evaluation services. The savings programmes could also provide further opportunities for outsourcing, along with increased MOD presence on our sites. There is likely to be increasing competition, but QinetiQ is well positioned due to its strong record in delivering improved services combined with significant savings (ie more for less) for customers.
MOD spending on science and technology will continue to be protected at 1.2% of the defence budget with an increased emphasis on disruptive technologies and innovation, and a move away from some more traditional research programmes. Space, cyber security and cryptography are among the priorities, areas in which QinetiQ has recognised expertise.
The Single Source Regulations Office (SSRO) is now fully established as the independent regulator for single source defence contracts, driving greater transparency that will help demonstrate the value for money the Government derives from Qualifying Defence Contracts (QDCs). The SSRO has confirmed the baseline profit rate for new single source defence contracts is 8.95% for FY17 (10.6% in FY16) and that over the course of FY17 it will consult again and develop the methodology for calculating the baseline profit rate in future years, potentially introducing multiple profit rates. This baseline rate acts as the starting point for agreeing the profit rates of new and renewed contracts, and suppliers can both under and over-perform the contracted rate depending on, for example, risk, capital servicing and project execution. Further updates and clarifications are expected to be published by the SSRO on other topics affecting QDCs, eg allowable costs.
Our combination of capabilities is unique in the UK and, consequently, approximately 70% of total EMEA Services revenue is derived from single source contracts, including the non-tasking element of the Long Term Partnering Agreement (LTPA). As we have said before, we anticipate that the majority of our single source revenue will fall under the regulations within approximately three years.
Our Global Products division has a significant US footprint, providing a route to the world’s largest defence market and, in the financial year to 31 March 2016, 6% (2015: 6%) of QinetiQ Group revenue was generated from the US Department of Defense (DoD).
In the US, the defence downturn is reaching the bottom of the cycle, with the President requesting continued increases to the defence budget and the budget for overseas contingency operations. A renewed commitment by US military customers to unmanned systems products is reflected in plans to award new competitive Programs of Record over the next two years to enhance and sustain the US unmanned systems capability as a funded capability in the DoD budget.
The President has requested an increased research and development (R&D) budget for defence which includes the Defense Innovation Initiative, also known as the Third Offset Strategy, “an ambitious effort to identify and invest in innovative ways to sustain and advance America’s military dominance for the 21st Century”. This initiative is expected to put new resources behind innovation and, in particular, research and development in technology to support and optimise the interaction between humans and machines. These initiatives align with a number of areas in which QinetiQ has distinctive strengths including sensor fusion, man-machine interfaces, autonomy, and unmanned vehicles.
QinetiQ’s third home market is Australia. The Australian Government is responding to the need to modernise its defence equipment and now plans to replace the majority of its platforms over the next 15 years, supported by an increase in defence expenditure to 2% of GDP. In line with the recommendations of its First Principles Review, in which our Australian business played a role, the Government is also pursuing a defence transformation programme similar to that whichhas been underway in the UK since the beginning of the decade.
Many of our unique capabilities are attractive to customers beyond the UK, US and Australia, and we have made it a strategic priority to develop new home markets through partnerships, and grow sales by exporting our products and services. For example, as the Canadian Government pursues similar defence transformation programmes to the UK, it values the advice, test and evaluation that we can provide in support of better procurement.
In Sweden, where QinetiQ operates the Flight Physiological Test Centre for the Swedish defence department, the defence environment is similar, with budget pressures evident against a background of heightened security threats. Such pressures, on Sweden and other Northern European nations, can drive greater cooperation on specific programme opportunities and greater interdependency between allies in capability provision.
Further afield, in Turkey and the Middle East, budgets remain more robust, offering increased export opportunities for defence products and services, albeit these and other nations are determined to develop indigenous capability for both economic and sovereignty motives. This can provide seams of growth potential for QinetiQ’s most distinctive capabilities but accessing these markets will require thoughtful partnering approaches and alignment with UK Government export initiatives.
Looking across our home and overseas markets we see a number of key themes. Governments are having to respond to increasing security threats with reducing budgets. They need to deliver more with less. So not only are government customers seeking greater value for money from their suppliers, they are also looking for assistance in meeting their own ‘efficiency’ challenges. Companies like QinetiQ, with a track record of delivering improved productivity and innovation in products and services, are strongly positioned to help.
Most governments recognise that being efficient is not enough and they also need to innovate to respond to these fast evolving threats. They are seeking new approaches to innovation in both equipment and processes so that they can rapidly integrate new technologies into existing capabilities. Investing and applying our core competence for customer advantage in defence and commercial markets is a strategic priority for QinetiQ. Many customers are keen to capture the innovation that comes from universities and small and medium sized enterprises (SMEs), and are looking for assistance from organisations that can help them connect their supply chains. Similarly, governments are promoting multilateral approaches to developing new capabilities, encouraging suppliers to cooperate internationally.
QinetiQ already delivers an ‘innovation integrator’ role, building networks of suppliers to bring together Government, industry, SMEs and academia in collaborating teams and thereby facilitating innovation at every stage of the procurement process. Our Cyber Information & Training (CIT) business, for example, is the MOD’s leading supplier of C4ISR research, managing framework contracts for the MOD that involve more than 100 UK SMEs.