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To: ec Mr Scholar
Mr Macdonald
SECRETARY OF STATE ) separate Mr Baker CGBPS
MR MCCARTNEY ) copies Mr Macintyre CII
Mr Fraser IBB
From: Mr Wheeler IMT
Mr Sklaroff COM
DAVID SIBBICK Mrs Britton PORT
Director Posts Dr Hopkins CII
_BPKG _ Mr Whitehead CGBPS
i : Ms Anderson CGBPS
Mr Corry SpAdv
Mr Wegg Prosser SpAdv
6 November 1998
BA/POCL COUNTERS AUTOMATION PROJECT: HORIZON
Issue
An update on where matters now stand, with particular reference to John Roberts’
letter of 4 November (attached). (NB the supporting documentation referred to is
that circulated under cover of Isabel Anderson’s minutes of 27 and 28 October.)
Recommendation
2. (i) To reply to John Roberts in terms of the attached draft.
(ii) To note the position reached in the discussions between ICL and the
Post Office.
Timi
3. Routine, though the letter to John Roberts should ideally issue today (Friday
6 November)
4. Ministers decided on 9 September to allow a further month for negotiations
between BA/POCL and ICL to try to reach agreement on revised contractual terms
for carrying Horizon forward (Option 1). They also commissioned two additional
and parallel strands of work. The first was on the alternative options of proceeding
with Horizon but without the benefit payment card (Option 2), or of terminating
Horizon as a whole(Option 3), so that value for money comparisons could be made
between all three options. Second, the Secretary of State was charged with taking
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@ vcs five specific points relating to the Post Office and the counters network.
These three strands of intensive activity were overseen by the Treasury-led
interdepartmental Working Group, whose report on progress by the end of the
month specified by Ministers is at Appendix A.
() The negotiations
5. To assist with the first strand of work, the negotiations between BA/POCL
and ICL, Graham Corbett, Deputy Chairman of the MMC and former Finance
Director of EuroTunnel was appointed to chair the negotiations. KPMG were
appointed to assist him, particularly in understanding and validating the business
cases of each of the contracting parties. Mr Corbett’s report is at Appendix B.
“ The fall-back options
6. KPMG were also asked to undertake a major piece of work on the second
strand of activity, that of enabling value for money comparisons to be made
between the three options. KPMG’s report is at Appendix C.
(ii) The five points
7. Most of the work on the third strand, the five points addressed to the
Secretary of State, consisted of dialogue between ourselves and the Post Office, the
outcome of which is recorded at Annex A to Appendix A. However, on the
transparent funding/social value of network issue, Price Waterhouse Coopers
(PWC) were commissioned to carry out a first quick cut at the problem of
attributing social value to the network. Their report is at Appendix D. The Post
Office also commissioned PA Management Consultants (who had been used by
Adrian Montague’s Expert Panel) to carry out an audit or evaluation of the changes
that had been put in place to the Horizon programme management.
RESULTS FROM THE FIRST FOUR WEEKS
@) The negotiations
4. By the end of the four weeks the negotiations chaired by Graham Corbett
between BA/POCL and ICL, had failed to find a commercially acceptable basis
for continuing with Horizon. However, at the eleventh hour, ICL signalled that if
some form of joint venture or joint working with POCL could be devised to give
ICL confidence that the full commercial potential of Horizon would be aggressively
exploited, it might then become possible to close - or at least to substantially
narrow - the gap between the two sides. Ministers subsequently agreed to a
further period of two weeks for talks between POCL and ICL, who are to report
back by 9 November.
(ii) The fall back options
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@ The work carried out by KPMG has demonstrated that, on a like for like
basis, in value for money terms there is little to choose between the three
options, and that such differences as there are fall well within the margins of error.
Comment: However, when the other advantages of continuing with the project
- minimising the risk of damage to the network of post offices, to ICL, to the
credibility of the PFI process especially for this type of project, and to prospects of
inward investment from Japan - are taken into account, the case for continuing
appears overwhelming provided a sensible commercial deal can be negotiated;
(iii) The five points
6. On the third strand of work, the responses we were able to give on the five
points to the interdepartmental Working Group are at Annex A to Appendix A. On
the first four, namely strengthening Horizon project management, giving POCL
management a more commercial focus, exploring the scope for partnerships
between POCL and the private sector, and developing Horizon to support social
banking and broader account-like services, the Working Group’s reaction (set out at
paragraph 4.2 of Appendix A) was that the Post Office is belatedly moving in the
right direction, though in some areas much remains to be done. On the fifth
point, concerning a transparent funding regime and the social value of the network
of post offices, preliminary work by Price Waterhouse Coopers suggests that the
“extra” cost of delivering benefits through post offices rather than ACT is
more than offset by the social value added.
7. A more detailed summary of the main elements of the work described above
is at Appendix
TWO FURTHER WEEKS
8. At the end of the first four weeks, a deal was on the table that would have
given ICL a “profit” (expressed as a positive net present value, or NPV) of around
£50 million on the project from this point onwards. But ICL insisted that they
had already sunk or committed some £250 million and that the proposal therefore
required them to accept a loss of some £200 million on the project overall. This was
unacceptable.
9. However, ICL’s remuneration under the contract is on the basis of a fee per
transaction handled by the system. The calculations shown above were based on
POCL’s forecasts of transaction volumes. ICL believe that these forecasts are
unduly pessimistic, and that if they were able to join with POCL in marketing the
system a great deal more effectively than POCL alone will be capable of doing,
substantial additional traffic could be generated. This in turn would generate
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additional payments to ICL and would improve the NPV of their business case. If,
for example, sufficient additional volumes could be generated to increase payments
to ICL by some £50 million over the remainder of the contract period, the loss to
ICL overall would reduce from £200 million to £150 million. At that point, ICL
would need to come forward with an offer to absorb at least a significant proportion
of the remaining £150 million, and the public sector side would then make a
judgement on whether it was prepared by one means or another to bridge whatever
gap remained.
10. This in essence is what the last two weeks have been about. ICL have made
three demands. First they want a structure in place for the joint development of
Horizon’s commercial potential. The Post Office agree that there is potential
through working with ICL to develop Horizon’s commercial potential more fully
than their own business plan envisages, but they want to keep such cooperation to a
working arrangement, under which they retain full control of their commercial
destiny. Second, ICL want POCL to designate them preferred supplier for all
POCL’s IT requirements. The Post Office are willing only to concede minor
elements of this. Third, ICL want POCL and ICL Pathway to take cross-
shareholdings in each other. The Post Office see no commercial case for conceding
this.
11. ICL were due last night to submit a final set of interlocking proposals to the
Post Office last night. We expect to get a read-out of these later this morning,
together with initial reactions from the Post Office. At this stage, however, the
prospects of a deal which would satisfy the criteria set out in the Chief Secretary’s
letter of 30 October do not look promising.
DAVID SIBBICK