With the reform of the defense industry, Ukraine seems to be banking upon a simple solution. So far in Ukroboronprom, we have a change of managers and a request for Hr 32.5 million worth of audit, as if this is going to solve something. It will not.
But before explaining why, we need to understand the system as it is now. The defense industry cannot be reformed without reforming the defense system as well. The one serves the other. In Ukraine, we have two completely separate strands of defense business, public and private. They are as chalk and cheese.
The public organization is still Soviet in management, organization, and culture. It has an incestuous relationship with the Ministry of Defense that has allowed corruption to flourish for the benefit of both.
It is effectively publicly funded, even the bits that do not work. It is managed top-down. It is oversized and overmanned, and bureaucratic in management. Efficiency and initiative have been squeezed out by history and corrupt practices. It is ineffective in all ways needed to support the country and defense. It has never had the capability to create and deliver the needed products and services for a modern defense system and is not improving today to do so. The old facilities are rotting away for lack of proper investment and knowledge. The industry has been used by previous political leaders to gain money for their own purposes. But do not be fooled that paying managers better will solve anything. The last top staff members were paying themselves handsomely for doing nothing of value but at the same time paying the workers little, and sometimes nothing at all. There is a near-total absence of cooperation with private companies and innovation remains a dream
The private companies are mainly small but with huge energy and often powerfully driven by personal experiences from war. They are active, flexible, imaginative and efficient. They are producing products that are badly needed by the front line. The staff is properly paid and motivated.
But here is the rub. Private companies are met with a barrier of Ministry of Defense secrecy about plans and often a totally inadequate understanding by officials of what new products are for and can do. It is, therefore, no surprise that many products find themselves being used first on the frontline brought there by volunteers and paid by volunteers long before the Ministry of Defense grasps they are important. Worse than this, companies taking ideas and products to ministry or the staff have been met with the question “how much?” and that is not an inquiry about the price.
The problem therefore is far too complex to be identified clearly with a simple audit.
Marianna Kozintseva, formerly of Morgan Stanley, on her Facebook page, highlighted why: “what is necessary is forensic, not just financial audit. The two have different objectives and do not overlap.
Forensic accounting is a specialized branch of accounting that requires training in fraud detection. A forensic auditor examines a company’s system of internal controls to identify any weaknesses in the controls designed to safeguard assets and to determine whether anyone in the company has exploited control weaknesses to misappropriate assets for personal gain. It seeks to identify the asset-theft fraud and the fraud perpetrator and will gather evidence to help convict the perpetrator in a court of law. A forensic auditor will not express an opinion on company’s financial statements. In contrast, the financial audit will investigate whether the company’s financial statements, in all material respects, fairly state a company’s financial position as of a certain date. An auditor conducting a financial statement audit will not investigate asset-theft fraud.”
I suggested that we needed to go even further and conduct full due diligence on the organization. Marianna then wrote that there was, in fact, an even deeper stage of analysis which was “forensic due diligence” with a more detailed bottom-up approach.
“These analyses help in identifying red flags, which may indicate potential issues such as inflation of revenues, potential diversion of funds, the existence of accommodation transactions, non-existent vendors/customers, issues of conflict of interest, anomalies in related party transactions or undisclosed related parties.”
I would suggest that we need to do something close to forensic due diligence alongside an audit. In this we must analyse things like value and utility of property and lands, quality and usefulness of machinery and full stock checks, these two by skilled foreign industrial engineers from a defence firm like Patria or BAE systems, past, present and future contracts, value and potential of patents and the quality of human capital. Without all this, we are unlikely to get the realistic picture we need to know where to take the organisation next.
There must be a serious question asked why Ukroboronprom is only asking for a simple audit. It may be pure ignorance of the need for doing more, but more likely it reflects the desire for a box-ticking exercise to be conducted so we can go back quickly to business as usual.
The problem of Ukroboronporm cannot be solved inside the organization alone. There needs to be a radical rethink of how the ministry and the General Staff do their business with the defence industry. The problems created by the current desire for centralization are manifold. There lacks a proper devolved defence management system where front-line commanders lead the development and changes, not the General Staff as now. Today grand plans are the order of the day, not an incremental change to improve things. The extreme waste of money on the navy “spy ship” is a typical case in point. The navy commander was not involved at all in the planning or purchasing process and the ship was not part of the international partners agreed a navy strategy. It is little wonder that foreign officials trying to help Ukraine develop better forces scratch their heads in amazement.
Centralisation is not the only problem. The lack of proper defense doctrine setting out “what works” and how we intend to fight a successful war means that the plans for fighting, equipment development, maintenance, and even for training needs like simulators, are not based upon any well-argued or intellectual framework. It seems to come down to buying more of the same (as the rule book says) – minus innovation or technological improvement. It reminds me of the introduction of the machine gun in WW1 where the British were slow to understand the powerful utility of the weapon whilst the Germans deployed them in large numbers widely. We likely need a totally new look at who decides what should be bought for our forces. The real expertise appears to lie outside the military not in the staff and civilian experts and companies must be involved at the thinking stage not only when contracts are being let.
The reality is that modern warfare also needs a much more intelligent and reactive approach to procurement, both from Ukroboronprom and with private industry. No business could survive profitably the way the MOD and Ukroboronprom currently do things. They are both simply too slow. They lack the awareness for customer-centered innovation, especially in key areas like vehicle maintenance, modernization, and producing and delivering spares. In any mobile battle the demands will grow exponentially and the ministry and Ukroboronprom will be simply unable to cope just as they were unable in 2014. A completely new and radical process approach is needed to provide fast support that gets closer to real needs and cuts out the heavy and slow-to-respond planning. If supermarkets can manage daily restocking so can MOD. In war, every day counts where front line support is concerned.
So what to do? I suggest several steps. First must be to analyze Ukroboronprom properly both for all that has happened illegally and what modern capacity the company can exploit for the future. Then whatever little can be saved must be floated on the market as individual companies to compete for contracts as any other company. Where an unprofitable business or product is still needed for defence then alternatives must be sought, or new management brought in to make the company work properly. Secondly must be to remove the monopoly and secrecy that stops private business joining the system on equal footing for contracts or for exporting easily. Third must be a totally new planning approach within MOD. The first element is to improve the technological and military know-how about modern battle and to remove the outdated “gatekeepers” currently blocking private innovation entering the defense system. Second, there is for a customer-centric approach to innovation and development using all available knowledge intelligently. Then a new budget and planning process is required for how to conduct procurement and logistic support for fast-moving activity requirements, not the slow support for a static front line as now.
Admiral Igor Kabanenko of UA.RPA also suggests that we need to group the businesses into themed clusters. Certainly, there is strong evidence that geographical clusters create something greater than the sum of the parts. Silicon Valley is the main case in point. In UK there is a highly successful aviation cluster in Farnborough built around the airfield of “Air show” fame. There is a large wind tunnel there for shared use and the spin offs of new materials and design have also seen not just developments for aircraft but also new sports products like bobsleighs. How to create clusters is another subject but it is very clear from the experience of Moscow that control is not the answer. Over-planning simply squashes entrepreneurialism and innovation rather than allowing new ideas to develop.
So how changes to defense industry can be understood, initiated, managed and encouraged is complex. The danger is that the Soviet-type “controllers” win the argument rather than those who favor letting the market set the conditions. What is clear is that without exposure to open competition the corrupt, lazy and wasteful Ukroboronprom will never deliver what we need. The danger in all this is that Russia is moving faster and more determinedly with defence industry change than we are.
Remarkably as we saw with the recent nuclear accident – not all their progress works.
