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Date: 26 September 2019
Director General: Mark Russell (UKGI)
Lead Officiat Tom Aldred (UKGI), Beth White (BEIS
Lead Official Telephon
Recipient To Note / Comment To Approve / Decide
Permanent Secretary x
Kelly Tolhurst x
Post Office Limited (POL): Quarterly update
Summary
1. This is a regular quarterly update on Post Office Limited (POL) and follows the
previous update submitted on 13 June.
Timing
2. Regular quarterly update. This also provides background for your upcoming
meetings with Nick Read (30 September and 17 October) and Tim Parker (date
tbc).
Overview
1. The new CEO has arrived at animportant moment for POL. He is working to a
100-day timetable with a view tooutlining his strategy before Christmas.While
headline financial performance is good and with a positive outlook financial
controls need to improve, and we are currently withholding funding pending
information on investment spending. The litigation case has exposed both
historic weaknesses and an ongoing need for culture changén the business.
Legal
2. Sparrow litigation. POL has been developing its strategy for mediation,
including detailed work by its legal advisors to understand and verify the
magnitude of potential claims. Separately, UKGI and BEIS are engaging with
HMT to discuss preparations and clearance processes for a possible
settlement. The legal advisers have produced a firstdraft for the Board for
approaching settlement including a firstrange of estimates. The Board has
asked for more work to be done to improve its understanding of how the
claimants’ perspective on the range of outcomes. The final strategy will be
contingent on two processes: the judgment of the ‘Horizon’ trial (no date
confirmed, but expected in the next month and the Court of Appeals decision
on whether POL can appeal the first‘Common Issues verdict (an oral hearing
is due on 12 November). Mediation is unlikely to start before December but we
may need to move quickly to obtain the necessary approvals.UKGI and BEIS
comms have met POL to discuss comms around the Horizon judgmentFurther
advice will follow the judgment and appeal hearing.
3. ‘Starling’ litigation. A separate litigation (Starling) relates to 123 Postmasters
who have commenced proceedings in the Employment Tribunal claiming _
“worker” status
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he case is expected to be heard by the Employment Tribunal
in 2020, with a preliminary case management hearing set for 11 October 2019
after which we will provide a further update.
Governance
4. New CEO. Nick Read joined as CEO on 16 September, and you are meeting
him on 30 September, and again with Kelly Tolhurst on 17 October He was
previously Chief Executive at Extra Energy (2018-19) and at Nisa (2014-2017).
UKGI and BEIS met with Nick on 17 Septemberand he attended his first Board
on 23 September. He has publicly stated his intention to establish a clear vision
for POL within 100 days (by Christmas), and to agree this both across the
business and with its wide set of stakeholders.As part of this, we understand
that Nick plans a series of'roadshows with staff and postmasters.
5. Bonuses. Remco has discussed and in principle agreedmeasures to provide
significantly greater discretion in future. The company’s ability to exercise
discretion in a very wide range of circumstances has been clarified.
Importantly, in relation to LTIP, discretion would ae to payouts as well as
grants: Based on legal advice receiv leg
Legal Privilege
6. Future of STIP and LTIP. We have also been working with Remco on revised
measures for STIP and LTIP for FY 20/21 onwards. While EBITDAS has been
effective in focusing management on the turnaround and restructuring, we think
we should think about moving away it because it doesrt capture change spend
very well or balance sheet efficiency. We have also proposed a change in the
operational performance measures to include achieving improvements in areas
that the Common Issues judgement highlighted We are currently waiting a new
proposal from Remco. The company is also likely tochange the remuneration
scheme for employees below the senior leadership group (alarger group than
the group executive) to align incentive pay more closely to the performance of
the relevant business unit.
7. Executive team and succession planning POL’s senior leadership team is in a
period of significant transition. 2019 has seen the departure of the Chief
Executive, General Counsel, Chief Information Officer and HR Director. Nick
Read is also likely to restructure the leadership team and may make a
significant number ofsenior hires, most likely externally.
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8. We have seen numerous examples over the last year or so of the company
lacking commercial expertise and being poor at execution. The company is
also missing a strategy/corporate development function thatcan: address the
many strategic questions the company faces, and coordinate and oversee the
execution of specific projects/negotiations. We have raised this a number of
times in the past and we are hopeful that Nick Read willtake active steps to
bring much more commercial DNA into the company.
9. NEDs. Following a selection process, POL hasidentified three lead candidates
for the two open roles (all women, one BAME) and we expect them to request
shareholder approval shortly. We are hopeful that they will be in place for POB
next Board on 29 October, but to guard against the prospect of a double gap on
the Board, we have agreed to extend the term of one of the outgoing NEDs
(Tim Franklin) until both new NEDs have joined the Board.
10.New leadership at PO Insurance POI have appointed Ed Dutton as CEO to
execute its growth strategy. Ed had previously been CEO of British Gas
Insurance for 8 years. Rob Clarkson, the previous head is leaving the company.
In addition, Tim Franklin has been appointed as POI Chairman.
11.Culture change. The litigation case has exposed historic failings in POL’s
dealings with postmasters and a degree ofcomplacency in preparing for, and
reacting to, an adverse judgment. At the UKGI Board, you indicated that you
see the POL Board's attitude to 2019/20 bonuses as reflecting the same
problem, and that culture change must become a primary focus for the senior
leadership of POL and especially its Chair, Tim Parker.Encouragingly, POL’s
Board had a discussion on corporate culture at Septembe’s Board and UKGI’s
NED suggested they commission an ‘organisational health check to provide a
clearer picture of the current situation
12.Engagement with the Chair You are due to meet with Tim Parker in October, to
provide clear direction on BEISs priorities. We would also expect to send a new
Chair's letter in early 2020 to supersede that of January 2019. We would also
recommend that you aim to meet with theChair on a quarterly basis, in line with
best practice across the UKGI portfolio.
13.Framework Document POL is finalising a corporate restructuring for increased
efficiency and to ensure a robust governance framework is in place-They have
decided against forming a newHoldCo, instead moving their financial services
operations into a new expanded Post Office Insurance subsidiary. They have
provided external legal assurance that this will comply with the relevant FCA
regulation. As part of the project, we are revising POLs Articles of Association
and establishing a Framework Document for the first time. This will provide
greater clarity on our relationship, governance requirements and information-
sharing arrangements. Agreement has taken longer than expected, with POLs
engagement generally slow and unduly legalistic. A few outstanding issues
remain, focusing on Shareholder reserved matters and applicability of HMG pay
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guidance, but following progress at the September Board, we hope to agree
these shortly.
14.Compliance with pay quidelines POL have now agreed to stop offering private
medical insurance (PMI) to new joiners and to state within the Framework
Document that they will complywith guidance on public sector pay and terms.
This is a positive development as it had been a sticking point for several
months. POL is not currently required to comply with the £95k cap on exit
payments but have indicated that they would face significant problems if they
were. These relate to long-serving employees are covered by pre-existing
agreements with unions, as well as the remuneration of their most senior
executives.
15. Shareholder meeting UKGI and BEIS will hold a formal Shareholder meeting
with POLin November (date tbc) covering issues of both operational
effectiveness and policy. While standard practice across the UKGI portfolio, this
was a missing piece of POL’s governance and holding them every six months
been stipulated as a requirementwithin the new Framework Document.
16.Board review _and Chair appraisal POL completed a Board evaluation in
January 2019. We have agreed with the SID to delay the next reviewuntil
March 2020 to allow time for the new Board members to form a view on its
effectiveness. It makes sense to carry out the Chair appraisal at the same time.
This will be led by the SID and you will be invited to share your thoughts on the
Chair's performance.
Financial and Operational performance
17. Trading update. POL achieved a trading profit of £24.5million in the first five
months of 2019/20. This was ahead of budget by £1.9 million, falling to £0.3
million on a like-for-like basis that takes into consideration accounting and
timing differences. Turnover has been slightly below budget due to challenging
conditions in the travel business and across the Financial Service, Telecoms
and Insurance divisions. Retail and Identity revenues continue to perform well.
The improvement in profit reflects POL’s continued progress on cost
management. Annex A has more detail
18. Investment _spending. BEIS allocated POL £210m of investment funding
(‘change spend) for the period 2018-2021, of which they drew down £168m in
2018/19. While some projects have changed in scope and cost, the overall
portfolio is on track to meet its budget. We are currently withholding the
remaining £42m until POL provide a rolling 3-year lookahead on investment
spend. Once this has been provided (now expected in October), we would
expect payment to be approved. Annex B has more detail on POLs investment
spending. You have received separate advice from Alex Cole recommending
release of the Q3 subsidy payment. This advice also provides a detailed review
of POL’s performance against the obligations and criteria set out in POlts
Funding Agreement
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19. The company continues to have problems with the way change spend is
authorised and controlled. We asked for greater disclosure and analysis in
2018 and asked for an internal audit to identify the issues withthe change
spend process and recommend changes. Despite this, problems have
continued. This has highlighted that POL has been insufficientlyfocused on
managing change spend and in future it will need to reduce its overall need for
change spend and improve its efficiency if the company is to be genuinely
financially self-sufficient
20. Overall, the DMB restructuring programme seems to bemanaged reasonably
well currently, but the record in IT is very mixed. The company seems to have
done reasonably well when the organisation is focused on a small number of
large and mission-critical projects. In the last year or two attention has turned
to projects that are enhancements or provideessential new functionality and
these have sometimes been more problematic. As a result, the company has
been very slow in digitising its business in line with a coherent customer
proposition across the group and developing good management information
systems that can assist postmasters in running their businesses and POL in its
decision-making. The company has recently recruited a new Chief
Transformation Officer who is in the process of a major reorganisation of the
approval and monitoring processes, which we hope should lead to an
improvement.
21. Our experience on change spend has also informed our view on incentive pay.
The company has been too focused on EBITDAS at the expense of managing
the much larger value in change spend. The use of cash flow metrics would
mitigate this problem significantly. We raised this at Remco in early 2018 but
Remco wanted to stick with the existing focus on EBITDAS. We have moved
this debate on significantly now as noted above.
22. Network performance At the end of August 2019, there were 11,628 post office
branches, comfortably above the network commitment of 11,500 In addition to
the franchising programme (see para32), POL also plans to open 220 new
post offices in 2019/20 (92 have opened YTD).The use of outreaches has risen
significantly rising 9.5% p.a since 2014/15, to reach14% of the network (1,647
branches). Officials are exploring the role of outreaches as part of the long-term
policy review. UKGI have encouraged POL to analyse the financial stability of
its partners, which has raised concerns about some of the multiples which host
post offices. McColls is the largest in this category hosting over 650 branches.
POL will now be developing mitigation plans.
23.Network Accessibility and SGEls POL continues to meet the geographical
access criteria (annex C). POL provides a range of Services of General
Economic Interest (‘SGEI”) and UKGI has asked POL for assurance that these
meet the contractual requirements with Government departments. This work is
being carried out by POL's internal audit. The annual Network Report has been
approved by Board and willshortly be layed in Parliament.
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24.5 Year Plan (5YP). POL has started work on a 5YP which was discussed at the
Board's July away day, and also with UKGI. The plan sees growth inrevenues
through BF2 and improvements in FX and Insurance,and falling costs via a
reduction in headcount, including completion of the DMB programme. While
profits are forecast to grow, the business would not generate any cashdespite
the additional revenues from the banking framework,known cost reduction
programmes and expectation that change spendshould now fall significantly In
our view the plan we have seen should not be acceptable to theShareholder
and we have expressed that view to the company Nick Read will be reviewing
the 5YP as part of his first 100 days and will also incorporate conclusions from
the review of Agent Pay. We expect the 5YP to finalised beforethe end of the
calendar year.
Government Strategy and Spending Review
25.Long term policy work The BEIS Post Office policy team are working with
UKGI, POL and other stakeholders to develop options to advise the Minister
on the 16" October on the following areas:
e Funding, ownership and commercial sustainability: we are exploring the
feasibility of and case for continuing a Government subsidy post 2021,
taking account of POL’s aspirations to become commercially
sustainable whilst recognizing the need to maintain a footprint that
reflects POL’s social purpose balanced against fair agent pay.
e Sustainability of the network and workforce relations: we are exploring
a range of options from reviewing network size, access criteria and
definition of a branch to potential L&D and professional development
support offers for postmasters (to complement POL’s agent pay
initiatives).
e Role of social purpose: we are undertaking a review of cross-
government agendas that could link with POL’s ‘social purpose’
including the cross-government loneliness agenda (DCMS) and
community assets agenda (MHCLG). We are also considering the role
of community branches and exploring ways in which the social purpose
could be better defined and measured.
e Alignment of POL’s activities with wider Government agendas: we will
be undertaking further work to better understand opportunities linked to
digitisation of Government services vs tailored support for vulnerable
customers.
26.Future subsidy. POL’s draft 5YP included a proposal for £30m of annual
subsidy from April 2021. The 2018/19 cost of the uncommercial network was
£67m so £30m of subsidy would meet State Aid requirements.The subsidy
requirement will need to be consideredin light of the long-term policy work,
such as changes to the minimum network size or access criteria.
27.Subsidy waiver/dvidend. POL feel that they are some years away from being
able to pay a dividend. This is primarily because they may need to fund a
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settlement on GLO, but also because they want to finance significant ongoing
investment (of which we are more sceptical- see above). Work is ongoing at
Official level to develop a suitable dividend policy, including the potential for
POL to be able to instead waive the subsidy it receives.The aspiration for the
payment of a dividend in futureis to be inserted in the Framework Document.
28. Investment facility UKGI are working with BEIS Finance to develop a business
case for an investment facility that POL could use to finance material
acquisitions outside of BAU investment that it will be expected to finance itself
from 2021. We aim to conclude agreement on the investment facility, subsidy
and dividend policy as part of the next Spending Review.
POL Business Strategy
29. Agent Pay. POL is carrying out a Review of postmaster pay in light of an
increase in resignations, difficulty in recruiting people to run a post office and
significant parliamentary and media attention. POL is implementing some
‘quick wins’, increasing fixed remuneration by 10% for all community and hard
to-place branches and bringing forward increases for banking transactions
Plans for addressing morefundamental questions about the structure and level
of postmaster pay will be brought to the Board in October, and officials are
engaging with POL on this work These issues will be a crucial part ofthe 5YP
and the wider issue of how to improve POts relationship with postmasters
30. Royal Mail. Mails still represents a critical part of POLs business model. The
existing agreement with Royal Mail Group (RMG) ends in January 2022, with
exclusivity arrangements due to expire at the end of 2019. After a long pause,
RMG have now started to engage positively and both sides are targeting an
agreement on a new, non-exclusive 10 year deal early in the New Year. The
high-level understanding between the parties is that overall the economics for
POL should not change materially from the existing contract. Again, this would
be a significant achievement for the company if delivered. POL appears well
prepared for the negotiation, with a clear understanding of its red lines and aims
for the new contract.
3
.Royal Mail has received formal notice from CWU that it intends to ballot its
members for industrial action. Experience suggests CWU are likely to win the
ballot. We understand the earliest potential date of any action would be 29
October. POL is currently assessing the scope, areas and priority for
contingency plans with Royal Mail. POLare able to draw on preparations made
in of potential strikes in 2016/17.
32.Telecoms — Market_Sensitive Information POL’s July Board agreed that it
would proceed with the process which would either extendPOL’s contract with
Fujitsu or replace Fujitsu with anothersupplier , depending on the successful
bidder. This process is underway and is expected to achieve a significant cost
saving. The alternative of a sale is alsoplanned and the timetable and expected
valuation being developed. The Board will be updated in October.
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33. Franchising. POL is continuing to franchise its Directly Managed Branches
(DMBs). There are currently 151 DMBs and POL has exited 37 of the 69 DMBs
they plan to franchise in this financial year This ongoing programme has led to
a reduction in losses from this part of the network but continues to create noise
in affected communities, mainly due to misconceptions in the consultation
process. POL is currently reviewing its communications around the consultation
process to mitigate these misconceptions and are due to report on the
outcomes of this review on 30 September.
34.The Minister and officials are broadly satisfied that common concerns about
decreased accessibility, service level and quality in franchised locations are
addressed by POL on a case-by-case basis. We continue to work closely with
POL to equip Minister Tolhurst to address concerns about specific cases.
Customer satisfaction levels are typically high after franchising has taken place.
Further, we also plan to engage with Citizens Advice who are currently carrying
out research to better understand customer satisfaction and difference in quality
of service between traditional DMBs and franchised DMBs. Whilst they are due
to publish a report on their findings in January 2020, we plan to engage with
their recommendations early and build this into ourlong term vision work, as
appropriate.
35.BF2_ and Barclays. All 28 major High Street banks have signed up to the
renegotiated Banking Framework agreement, which will take effect from
January 2020, but Barclays have made the decision to uniquely opt out of cash
withdrawal services due to the increased rates. Minister Tolhurst wrote to
Barclays UK CEO Matt Hammerstein on 5 August to express her
disappointment with Barclays’ decision. Matt Hammerstein responded on 19
August to outline Barclays’ decision in detail and offered to talk officials through
their analysis, which we have accepted. Minister Tolhurst has also written to
John Glen MP (Economic Secretary to the Treasury) to suggest a call to
discuss the matter further, which he accepted and is currently being set up.
Following a conversation between Tim Parker and the Barclays UK Chair, Sir
lan Cheshire on 17 September, Sir lan undertook a review of their decision,
with the outcome of no change in their position. Barclays are due to start
informing their customers on 9 October;we are working with POL to prepare
communications for this.
36.As part of the renegotiated Banking Framework agreement, POL announced in
April that postmasters would receive increased rates for cash deposits from
October 2019. On 1 August following the July POL Board meeting, POL
announced that they would be bringing forward the increased rates for cash
deposits from October to August.
37.POca. Ahead of a meeting that was scheduled between Al Cameron and the
then DWP SoS Amber Rudd for 22 May (but subsequently cancelled, you
asked officials to send a note to DWP officials to provide background
information and analysis on (1) the impact of removingPOca from POL and (2)
POL’s suitability for involvement in the replacement scheme.Having worked
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with legal and procurement colleagues to ensure we do not encourage breach
of procurement regulations, a factual note was sent by Carl Creswell to Nick
Joicey (DWP Financial Director) and Tara Smith (DWP Finance and Banking
Director) on 17 September 2019.We will keep you updated.
38. Bank of Ireland POL and BO! have now signed a new agreement that will run
until 2026, releasing POL from some exclusivity in areas such as SME and
Investments offerings and improving the performance review and termination
mechanisms. This is a significant achievement for the company.Separately,
POL is seeking to reduce the costs of operating FRES, the travel money
business run as a joint venture with BO!
39.Cash_ logistics. POL undertook a strategic review into its cash logistics
operations and presented findings at he July Board. It has decided against
either a material acquisition or divestment in this areaand will instead focus on
optimising the current operation. It will look to develop its technology and
explore commercial partnerships to reduce the cost of excess capacity in the
market. POL is onboarding staff with relevant experience and creating a
business case.
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Annex A: Financial performance
Financial performance2019/20 Year to Date (YTD)
Actual Budget Variance Year on Year
(£m: (£
Retail (inc Payzone) I
Financial Services and Telco] :
(inc Insurance) H
Identity
Supply Chain/Other
== IRRELEVANT
Net Income
Agents Pay
Staff Cost
Non Staff Cost
FRES
Other Income Lo _ _
Trading Profit 245 I 226 I 19 I 17%
Revenue
The Retail and Identity businessesare up compared to budget predominantly driven
by mails and banking. This was offset by weakness in Financial Services, Telecoms
and Insurance mainly due to weak demand for foreign exchange and overseas travel
The Telecoms business continues to face a highly aggressive market with heavy
discounting.
Costs
Overall costs were favourable to budget,particularly non-staff costs. Half of this was
due to IFRS15 accounting adjustments that require costs to be recognised over the
lifetime of the contract, whilethe majority of the remainder is due to the reallocation of
GLO costs to other cost lines. Furthermore,Cost of Sales and Agent Pay have been
impacted positively by lower revenues.
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Annex B: Investment Performance
The latest quarterly update on investment performance came to the July Board. POL
has reprioritised its portfolio to keep within its planned budget o 7A number of
key projects were either delayed, put on hold or reduced in scope:
- Retail Point of Sale (IT integration to enable Post Office transactions from an
independent retailers till)
- Youth Strategy
- End User Computing (IT project looking at bringing the management of some
hardware in-house)
- Self Service Kiosk procurement
In Q1, POL underspent by compared to budget, due to delays in four
workstreams: PCI compliance, DMB franchising, BOI negotiations and target operating
model. We have been reassured by the company that these delayed projectswill
recover during the year and still have strong business cases. An exception to this is
PCI compliance for which completion is delayed until late 2020 due to difficulties POL
are having in solving the problems. This is an essential regulatory project that must
proceed until completion These delays have meant benefits have not been fully
delivered either.
Project spend and benefits, Q1 2019/20
Qi Fy1920 I a1 FY1920
Variance
Actual Budget
Variance
Simplity the retailer proposition H
Modernise our products and services
Build innovative, flexible and secure IT i {
Diglise and optimise the business ; i
Modernise our skills, polices and processes
Non-UKG! Funded
Total Change Spend
Q2 2019/20 investment spending is forecast
DMB programme, fieusvwnion HR programme,
improvements an
BEIS funding supports POL’s investment programme, limited to projects approved at
the Funding Agreement (Jan 2018) This does not include the legal costs of the
litigation.
POL has allocated a further of investment spend for 2019/20 for responding to
the outcome of the litigation, including updates to the Horizon system, accelerating the
implementation of the field manager structure and updates to the Branch Hub. Little of
this has been spent to date as the business cases are being developed and
scrutinised.
POL have restructured this area of the business and appointed DarZinner to a new
role of Chief Transformation Officer. Dan has been tasked with implementing a new
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centralised investment spend portfolio aimed at removing duplication between different
siloed business units. A follow-up to the UKGI-requested internal audit report into
investment spend controls has been delayed to early.
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Annex C: Network update
Branch numbers (as at end August 2019
Mains Traditional Outreach Total
Number 3,411 4,019 158 2378 1,662 11,628
Programme Commentary
Franchising Plan to franchise 69 DMBs in 2019/20 (37 YTD). This can be poorly received b:
unions and local stakeholders but once open, customers usually welcome bette
accessibility and opening hours provided by the franchised branch.
New branches I Plan to open 220 new branches in 2019/20 (92 opened YTD) to meet undet
served customer demand
Outreaches Typically small, part-time branches using a village hall or a mobile van which
enable services to be provided to communities which would not otherwise
receive them. While Outreaches can represent the most appropriate provision i
rural areas for continuity of service, we have some concerns about their rapi
increase.
Hard to Place I Around 361 postmasters have expressed a wish to leave the network but canno
postmasters because, under current policy, POL is only allowed to pay compensation td
departing postmasters when a replacement branch is available - otherwise
communities will lose their post office.
Network Accessibility Performance
Criteria Total Total Deprived Urban Rural Postcode
Population Population Urban Population Population Districts
within 3 within 1 Population within 1 within 3 less than
miles mile within 1 mile miles 95%
mile Population
within 6
miles
Target 99% 90% 99% 95% 95% 0
Performance 99.7% 92.7% 99.4% 98.2% 98.6 4*
*POL is working on restoring services in these Post Code Areas
Network coverage of SGEls (Services of General Economic Interest)
Category of Service No. No. branches
branches — where service
required is available
1 pubie social benefits and tax credit payments to theI 11,000 11,491
2 I Processing of national identity and licensing scheme] 44 go I Client contract
applications , dependent
3 I Universal payment facilities for public utility services 11,500 11,625
4 I Access to postal services 11,500 11,625
5 I Universal access to basic cash and banking facilities,
a " 11,000 11,491
especially for rural customers and those on social benefits
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