Australia’s Munitions Contract Let the Supplier Grade Itself

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The Australian government announced on June 29, 2020 that its Department of Defence had signed a ten-year contract with Thales, extendable by award terms to fifteen, to run two Commonwealth-owned munitions factories, at Benalla in Victoria and at Mulwala, near the border between New South Wales and Victoria. The contract took effect on July 1, 2020 and was valued at A$1,261.0 million, including GST, at signature. In July 2026 the Australian National Audit Office published its second audit of the arrangement. It found Defence’s administration of the contract partly effective, and said it “has provided limited assurance that value for money has been achieved to date.”

The coverage I found went to the aging plants, a delayed and later canceled shell order, and a probity concern. Those problems are real, but the part I keep coming back to is a few paragraphs in chapter two, about how the contract decides whether the supplier keeps its profit.

What The Contract Was For

The report lists what Defence’s arrangements for the two sites were meant to achieve. The first is surety of supply of key munitions for the Australian Defence Force. Others are to “maintain domestic munitions manufacturing capability” and to “identify, develop, and manufacture new types of munitions to expand domestic capacity.” The contract also places emphasis, in the report’s words, on “reducing the total cost of ownership to Defence, and delivering efficiencies over time.”

So there were several purposes: steady supply, a capability the country could keep and grow, and lower cost. The auditors add something that matters for what follows: “While industrial preparedness and manufacturing uplift activities were envisaged as an intended outcome of the contract, they were not included as core contract deliverables.”

Where The Profit Pointed

The contract measures performance in three components: key performance indicators, strategic performance measures and system health indicators. “Thales performance against the KPIs is linked to the retention or loss of profit.” The report says 60 percent of the facilities operations payment and munitions order profit is meant to be at risk (in practice, the auditors note, 51 percent of the operations payment profit), with the amount Thales keeps determined by its results against four KPIs: return on operating costs, logistics efficiency, maintenance conduct, and delivery in full and on time for certain munitions orders. The auditors sum them up in a sentence: the KPIs “are focused on operation of the factories and timely delivery of munitions orders.” That covers the routine-supply purpose well, and the auditors say as much: KPI results “demonstrate whether specified controls and outputs have been achieved,” but “do not provide a complete basis for assessing delivery against the contract’s broader long-term outcomes and evolving industrial objectives.” One of the four is a cost measure, but the contract’s larger ambition, bringing down the total cost of ownership, sits in its pricing mechanisms rather than in the measures that move profit. I come back to those below.

The strategic measures and the system health indicators are where the harder things live. They cover, in the report’s words, “more qualitative or long-term aspects not easily captured in KPIs such as capability development, collaboration, safety culture, and contractor behaviours.” There are five strategic measures, and the second is called Capability Preparedness, which assesses “the contractor’s ability to operate and maintain the facilities to deliver capability.” That measure and one other, Facility Stewardship, are self-assessed by Thales. The auditors note, carefully, that as a result Defence’s assessment of the supplier against the strategic measures may not be accurately reflected in the reported ratings.

The strategic measures do carry consequences. Where there are significant performance concerns, including a shortfall against one or more of them, Defence may require a remediation plan or suspend some or all of the facilities operations payment, and it has to consider performance against the strategic measures, alongside the KPIs, when it decides on award-term extensions. Thales has to provide the underlying data for every measure, and Defence is to review it at the performance assessment reviews. What the strategic measures do not reach is the mechanism that puts profit at risk. Profit moderation, the report says, “is limited to the KPIs and does not apply to the SPMs or SHIs.” A footnote adds that Defence identified during negotiations that non-munitions work order profit was not at risk.

What Happened Outside The Measures

The contract’s estimated value has grown by A$607.6 million, or 48.2 percent, to A$1,868.6 million, largely through additional work and the contract’s price adjustment mechanisms. The auditors note that an increasing proportion of contract activity sits outside what the KPIs assess, including emerging products, and that profit moderation does not apply to work orders for industrializing and delivering developmental and emerging products. Their summary puts it plainly: “The strongest performance incentives and commercial levers remain concentrated on baseline operations and delivery of mature products.” “Delivery outcomes for routine munitions are stronger than for the developmental and emerging products,” they write. As of June 2026 Defence had spent A$42.5 million on developmental and emerging products that had not been delivered, or on orders that were canceled.

The cost purpose did not land either. “The contract has not reduced the cost of the facilities for Defence or reduced financial reliance on the Commonwealth.” The contract’s pricing mechanisms call for an approved total cost of ownership model, and as of April 2026 an agreed one was not in place. Defence assessed the model in 2024 as not fit for purpose, after having used an earlier version to set the operations payment for years three to five, which did produce an A$8.8 million reduction at the first cost review, and Thales told Defence that year that the model had been endorsed and was in use. Defence has paused its assessment of all efficiency proposals until the model meets its expectations. Thales has reported A$14.7 million in savings from approved efficiency initiatives. Defence has not verified that figure, and the auditors say the absence of an agreed model has constrained its ability to validate the savings reported to it.

It is worth being fair about the supplier. The six-monthly performance reviews the contract requires rated it satisfactory for the four periods covering 2021-22 and 2022-23, and the rating for the four periods after that was still to be determined when the auditors finished. Routine munitions, the work the KPIs watch, are where delivery is strongest. The auditors’ point about the self-assessed measures is about who does the assessing, and they raise it as a risk to the reported ratings rather than as a finding against them; they did find critical assets at both sites below target condition and asked Defence to strengthen its oversight of asset management. The report audits Defence, and its four recommendations go to Defence, which agreed to all of them. The auditors also say that Defence is managing performance shortfalls despite the unresolved deficiencies in the performance arrangements. The KPIs’ focus on operations and delivery was inherited from an interim contract, and work Defence and Thales had begun on the measures became a broader refresh of the performance arrangements from 2023, still under way in June 2026. A supplier that performs best on the work its profit depends on is doing what the contract told it to do.

The Buyer Decides Where The Profit Points

I have seen the same structure in ordinary enterprise contracts. The service credits attach to uptime and response times, while the reason the purchase was approved, lower cost or a capability the organization did not have, shows up in a quarterly review the vendor prepares from its own numbers. It is what a contract tends to look like when the measurable things get written first and the purpose is left to the relationship. In The Value Standard the contract is one of the decision artifacts that govern outcomes, and the profit terms in this one reached only the baseline work.

The fix is to write the purpose down as a measure before the contract is drafted: what the purchase has to produce, who produces the evidence, by when, and what changes if it does not arrive. That is the page a Request for Value asks a buyer to fill in before a solicitation goes out, and it is free to use on the Guides page. It helps the supplier too. A contractor that invests in the harder work, new product lines and lower costs, gets that work recognized in the terms rather than absorbing it under a contract that only rewards the baseline.

I have written about the same gap from other directions: a contract that paid for hours, a fund whose savings estimate decided approval and nothing after, an outcome price where the vendor counts the outcome, and an award that gave quality 30 percent of the weight and never checked that it arrived.

References: Australian National Audit Office, Defence’s Management of Contracts for the Supply of Munitions, Part 2, Auditor-General Report No. 1 2026-27, July 2026 (summary paragraphs 10, 11, 13, 18, 21 and 22; paragraphs 1.2, 1.3, 1.5, 2.2, 2.4, 2.10, 2.16 to 2.21, 2.29, 2.31 to 2.33, 2.60, 3.1, 3.6 to 3.8, 3.10, 3.13 to 3.15; footnotes 3, 26 and 27; Recommendation 2). Australian Defence Magazine, Domestic munitions contract under fire, July 9, 2026.

Keep reading: ACT III · Chapter 21: Decision Artifacts That Govern Outcomes