Buy Or Lease? Future Defence Equipment Procurement

Recent publicity around the Qatari purchase of a second batch of  24 Typhoon jets, plus 9 Hawk trainers and associated support packages, for £6 billion reminds us once again, if indeed we need reminding, of the fearsome costs involved in buying sophisticated military equipment.

Closer to home, the £7.6 billion expended on the UK aircraft carriers HM S Queen Elizabeth and HMS Prince of Wales has made a significant dent in the UK defence budget with more of the same in the offing with the Dreadnought class SSBNs on the way. Whichever way you look at it, defence doesn’t come cheap.

This article was submitted by Stuart Crawford, a regular officer in the Royal Tank Regiment for twenty years, retiring in the rank of Lieutenant Colonel in 1999. Crawford, a former SNP defence spokesman, now works as a political, media, and defence and security consultant in Edinburgh and is a regular commentator and contributor on military and defence topics in online and other media, including the UK Defence Journal and Thinkscotland.org.

I am no expert in the financial aspects of defence equipment procurement, but I remember the far off days when I was a staff officer tasked with massaging procurement programmes to ensure defence budgets could be met. Usually this seemed to involve extending the periods over which equipment was delivered to lower annual expenditure even although this ultimately meant that the overall cost was higher. 

Possibly instead of purchasing defence equipment, therefore, we should consider more carefully the alternative of leasing?  A lease is, according, to International Accounting Standard, “an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time”. It is a solution potentially relevant for any kind of fixed asset, but not obviously for consumables like ammunition or fuel, for example.  

It can, perhaps, be described as a “pay-per-use” service mode whereby the cost of designing, building and procuring a given capability, and the associated risks, are shifted to the private sector in return for a payment for the use of the capability. Risk is transferred at the price of loss of ownership while control and access are determined by contractual terms.

Leasing has been applied in the defence sector in various forms, perhaps most notably for gaining access to strategic transportation – sealift and airlift. Examples include the ARK and SALIS arrangements which deal with each of these respectively. In the case of ARK, the German Ministry of Defence and the Ministry of Defence of Denmark cooperates as Partners of the ARK Project based on a MoU.  The project charters sealift capacity from commercial companies and is able to re-charter (sub-lease) the share that exceeds its needs to other parties or the commercial market at conditions that continuously ensures the necessary readiness. 

SALIS is a multinational agreement signed between NATO and two companies aimed at filling the existing capability gaps for strategic air lift for outsized cargo. The contract is a pay-per-use one whereby participating nations acquire flying hours on an annual basis for their national use, with a minimum number of hours guaranteed to the contractor. Additional hours can be purchased on an as required basis on fixed conditions but not assured access. SALIS was planned as a temporary solution put in place while A400M aircraft was deployed and was put in place because alternatives (including leasing from the US) could not provide assured access.

Other examples include Germany leasing Israeli Heron 1 drones from March 2010 in Afghanistan, the Czech Republic’s $750 million deal in 2004 for 14 SAAB/BAE Gripen fighter planes leased for 10 years initially, and of course the UK MoD’s seven year “lease and support” contract with Boeing and the USAF for four C-17 Globemaster strategic transport planes in 2000.  In this latter case, rather than taking an option to extend the C-17 lease by two years the MoD bought the initial four aircraft in 2006 and subsequently purchased four more.  

So what are the main advantages and disadvantages of leasing military equipment?  The main rationale for using leasing arrangements is to avoid heavy upfront expenditure. Capability can be provided at relatively short notice, especially in the case of something like chartering of sea or airlift. It can also be used to fill temporary capability gaps and offers “operational convenience” in that the purchase procedures are fulfilled by the lessor. On the down side, it usually means that life-cycle cost of the capability can be higher than if purchased/developed from the outset with public funds.  Furthermore, the MoD may not have a full control over the leased assets and there is always the risk of being locked in a long-term commitment with limited possibilities of adapting. Much of this depends, of course, on the wording of the contract. 

These are but a few of the benefits and penalties which might arise via leasing but space does not permit further discussion in this article. Nonetheless, it seems that leasing rather than purchasing is an option worth pursuing. And, whilst there are a plethora of arrangements and contracts that might be applicable, perhaps a quick look at a basic, first principles (not to say simplistic) example based on car purchase might illustrate the idea. As any fule kno, the three most popular ways of buying a car these days are the personal contract plan (PCP), personal contract hire (PCH), and hire purchase (HP). The basic difference is that under PCP you have the option to either buy the vehicle at the end of the contract or enter a new arrangement (or walk away), under HP you end up owning the vehicle, and with PCH you only rent the vehicle and never own it.

So, let’s put all of this together and look at a very simplistic model for UK AFV procurement. Challenger 2 (CR2) is our ageing MBT and we have 408 of them – 227 currently in service, 59 used for training and the remainder in storage. Depending on which source you choose to believe it looks like the various iterations of the CR2 Life Extension Programme (LEP) might only be available to 150 of them because of budget constraints. To be honest, the upgrade programme now has all the signs of a classic British compromise – too little, too late, and too expensive for what is essentially a short-term solution.

Most serious British tank men, if given the choice, would plump for the German Leopard 2A7 as the replacement for/instead of CR2 LEP. Yes, there are questions about direct protection levels but in terms of firepower (especially commonality of NATO tank ammunition), mobility, availability and economies of scale it’s clearly the best option for the UK. And yes, I know we rejected it in favour of CR2 30-odd years ago but we should learn from past mistakes.

It is difficult to get an agreed cost for one Leo 2A7 as there are so many variables, but just for argument’s sake let’s assume a unit price of £5 million and that we would want 400 of them (wishful thinking). A total expenditure of £2 billion over, say, a four year introduction into service would have a significant impact on the UK annual defence budget of £500 million per annum. Leasing them instead might present a more acceptable financial profile. If we add 10% to the upfront cost for interest and depreciation and then divide the total by a typical MBT lifecycle of 20 years (not including upgrades), then we get a bill of £110 million per annum which might be much more manageable.

Now I am the first to admit that this example is simplistic in the extreme and does not include support and training packages, spares, improvements and upgrades and the like. But I think it illustrates the idea sufficiently for further exploration and debate. For those who wish to delve deeper there are a number of articles available online written by real experts who, unlike me, really know what they’re talking about.

There are clearly some procurement projects which don’t lend themselves to the leasing idea, for example the carrier programme or indeed the new SSBN project. For many others, though, it just might be appropriate. Perhaps we should consider it more thoroughly and not just continue to follow traditional defence equipment procurement in the UK?