The Ministry of Defence should shoulder more of the risk associated with big procurement projects and increase funding for industrial research and development, according to a report commissioned by BAE Systems, Britain's biggest defence contractor.
The report, carried out by Oxford Economic Forecasting, says the Government should "de-risk" contracts by carrying out more of the design and development work before they are finally let and entering risk sharing agreements with contractors to protect them from cost-overruns.
BAE has recently lost out in a number of high-profile procurement contests and last year had to write-off £750m to cover cost overruns on the Nimrod surveillance aircraft and Astute submarine programmes.
The report from OEF was commissioned a year ago, just after the Nimrod fiasco, when BAE's chairman and its chief executive were facing calls to quit. Its conclusions chime closely with the kind of proposals the company itself has been putting to ministers.
These involve a shift away from fixed-price contracts to ones that are more reminiscent of the cost-plus programmes that used to exist.
The author of the report, Erik Britton, said BAE had paid £80,000 for the work to be carried out but denied that OEF's independence had been compromised by the fact that the company had footed the bill.
He said the terms on which the MoD let contracts had to reflect the increased competitive threat BAE faced owing to the uniquely open nature of the UK defence market, which allows foreign contractors to bid for equipment orders without BAE enjoying reciprocal rights overseas.
The report estimates that BAE supports 111,600 UK jobs directly and indirectly and created £2.3bn in added value for the economy in 2002. It also points out that BAE's net exports of £2bn help reduce the UK's current account deficit by 11 per cent, while the company contributes more than £1bn in taxes a year. In addition, BAE spends £1.2bn a year on development, much of which is funded through government programmes.
Mr Britton said that the response to the report from within government had been positive, adding that the MoD had been "reasonably supportive" on the whole. "If the UK's defence procurement policy is to be sustainable in the long run, industry has to be offered something that makes sense. Either that means paying BAE more to bear more of the risk or reducing the amount of risk the private sector has to take."