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CONFIDENTIAL
b z
From: Geoff Mulgan
Date: 20 April 1999
Lord Falconer ees Steve Robson
Peter Scofield
Alan Milburn/PS
David Miliband
BA/POCL
1. You and other Ministers are meeting tomorrow to agree a final decision on
Horizon. Since I will be abroad on Wednesday and Thursday, I thought it
would be useful to set out some considerations in a note, in particular so as to
ensure that some additional issues (set out in para 9) are taken account of in
any ministerial discussions.
_ The desired outcome is that the meeting on Wednesday will confirm the route I
agreed at the meeting on Monday, namely to:
send ICL/Fujitsu a letter on Thursday with sufficient legal force in committing
the government to pursuing the revised smart card-based Horizon to avoid I
them having to make provision for losses in their consolidated accounts
set in train a radical overhaul of POCL to introduce new management, and to
incentivise them to maximise the returns from Horizon
. From the perspective of government as a whole, there is agreement that
pursuing B1 is the preferable option if it is affordable and deliverable.
Neither cancellation, nor continuing with Option A, is seen as credible either
in policy terms or politically.
_ DTI and HMT will therefore provide the meeting with some further
clarification on affordability and deliverability of B1.
On costs and benefits, the most recent figures suggested an NPV relative
additional cost of £700m, and additional potential revenues of about the same
order of magnitude.
6. These revenues would come primarily from new services for government.
ICL and POCL, working with CITU, have prepared a long list of new
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services including such things as a one stop shop for change of
address/personal circumstances, and voter registration. None is a big income
generator on its own. But 10 services each contributing up to £35m revenue
by 2005 add up to the £675 NPV.
7. In addition there are some estimates for additional commercial revenues, with
network banking and services for utilities about equal in terms of potential,
but both significantly less than the public sector revenues.
8. Clearly realising both the.public sector and private sector revenues will
depend on new personnel and structures in POCL.
9. However, there are two other key issues to bear in mind which have not been
factored into the discussions so far:
- First, the provision of more government services is estimated by CITU to
deliver potential savings to government of £2.5bn to £4bn. These figures may
be doubtful. But they suggest the order of magnitude of potential savings if
POCL can quickly become an automated front-end. These figures have not
been included in any of the NPV calculations because they accrue to
government departments, not to POCL.
- Second, delivering these savings, and the new demands for POCL, will
depend on a more concerted action by government in developing electronic
government. There are good intentions in the Modernising Government
White Paper, and some changes underway in the Cabinet Office. But there is
a long way to go before government policy on IT planning and purchasing is a
coherent and dynamic as it should be. If we go ahead with B1, it will be as
important to sharpen up the organisation of demand from POCL as it will be
to sharpen up POCL’s ability to meet that demand.
10. Taking all of the different dimensions of the issue into account, for what its
worth, my view is that even if some of the numbers change and appear to
demonstrate higher costs, and even if DTI/PO are resistant to structural changes,
the case for pursuing B1, and driving through parallel changes, will remain
significantly stronger than any of the alternatives.
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C. Oo
CHIEF SECRETARY §
BA/POCL: HORIZON
We are now facing an immovable deadline of 23 April. If by that date we
cannot make a decision, one will be made for us by Fujitsu and ICL’s auditors
which will make ICL insolvent. I thought it might be helpful if I wrote in
advance of our meeting with Alastair Darling on Monday to set out my view of
the present situation. The need for an automated platform for the Post Office is
well known and I will not repeat the familiar arguments, but essentially we have
three options remaining:
Option B “The Smart Card” - Until recently, this has appeared to offer the best
option for a successful outcome. The Smart Card would retain the Post Office’s
customer base and open the way to achieve many other government aims such
as social inclusion in the banking system. However, it now seems that there
may be significant additional costs for HMG attached to this option (which our
officials and KPMG are currently scoping) which may rule it out. It is,
however, my preferred option if we can 1ron out the financial question. In
particular, 1 believe that once an assessment of the income POCL might eam
from commercial exploitation of the platform, including early deployment of
the Smart Card, is available to us early next week the funding implications for
Government of this option may look more manageable.
Termination Quite rightly, for negotiating purposes, we have always retained
the “nuclear option” of termination. However, we must accept that this would
have immediate and serious consequences. ICL would be insolvent and would
begin legal action against HMG. Presentationally, fairly or unfairly, we would
be accused of ruining a highly successful UK company. It would also put us in
conflict with a major UK investor (Fujitsu) who, with its affiliates, employs
around 22,000 people in the UK. This could even impact more widely on
Japanese investment here. It would also be a high profile failure for PFI. At the
very least the loss of the long awaited Horizon project would seriously damage
sub postmaster confidence and lead te a rapid contraction of the Post Office
network. This would have a wider effect on the Post Office, on which we are,
of course, about to publish a long-awaited White Paper.
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dts
‘Deparment of Trade and Industry
a
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Option A (The Benefit Payment Card) Option A remains the Post Office’s
preferred option. However, in the light of BA reservations, ICL has all but
given it up, even though most of the technology is available. It is probably the
cheapest of the options and could still be a gateway to Option B. If we were to
decide on this route we would need to make clear that we would not tolerate
obstructive behaviour by any of the parties, and devise some form of oversight
to minimise it.
I do not believe there are any other options. Obviously, this is a serious
position, but I am quite certain we must be the ones to take a decision, not
Fujitsu ICL by default, and that of the three options termination would be the
most damaging to the Government.
Tam copying this minute to the Prime Minister, Alistair Darling and Charlie
Falconer.
16 April 1999
DEPARTMENT OF TRADE AND INDUSTRY
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dti
Department of Trae and lndusry
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LONDON SWIA 2AA
5
From the Principal Private Secretary
12 April 1999
Deve Pos,
HORIZON BA/POCL
The Prime Minister was grateful for the Chief Secretary’s useful minute of
9 April.
The Prime Minister duly met Mr Naruto this afternoon. Naruto was
accompanied by Keith Todd and George Hall (ICL) and an interpreter. Lord
Falconer, Steve Robson, Geoff Mulgan, Jonathan Powell and I were also present.
The Prime Minister opened by thanking Naruto for the sensitive way in
which Fujitsu had handled the closure of their semi-conductor plant in his
constituency. Naruto in turn thanked the Prime Minister for the help that Fujitsu
had been given by local agencies in the North East - 479 out of 550 employees
had now found new jobs.
Turning to the Horizon project, Naruto said that he was very grateful for
the work Steve Robson had done in recent weeks. He understood that ICL were
now close to agreement with the DSS and POCL on a new way forward. ICL
were fully committed to supporting the UK Government. He wanted to ask the
Prime Minister to give Steve Robson complete authority to bring the current
discussions to a successful resolution. On 23 April the Fujitsu Board would meet
to decide whether to support the new project. He personally looked forward to
securing a positive outcome. But he sincerely wished to get a legally binding
agreement before the 23 April meeting. Fujitsu was spending £5-10m a month
on the existing project. Nearly £300m had been invested so far. Sums of this
magnitude could not simply be ignored.
Keith Todd added that more progress had been made in the last 6 weeks
than in the previous 9-12 months. The project now in prospect was fully
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deliverable. Any assistance the Prime Minister could provide in bringing matters
to a successful conclusion would be extremely welcome.
The Prime Minister said that he too was very keen to make progress over
the next 3-4 days. His only concern was to get a viable system agreed that would
actually deliver what the Government wanted both now and in the future. Steve
Robson agreed - he was working towards the 23 April date and hoped the
remaining issues could be resolved.
I am copying this to Rod Clark (Department of Social Security), Antony
Phillipson (Department of Trade and Industry), Mark Langdale and Sebastian
Wood (Cabinet Office).
Toa
GRO.
JEREMY HEYWOOD
Ros Roughton Esq
HM Treasury
CONFIDENTIAL
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WITHOUT PRISUDICE
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Mr Sibbvek, COS »
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Depurtment of Trade and Industry Mr Mac drow Lf
1 Victoria Strect
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SW1H ORT Me Arechsun COM
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tyes i Sin nehaig ot Seka ,
BA/POCI. AUTOMATION PROJECT (“HORIZON”)
Thank you for sccing me yesterday.
now understand that the Government has reconsidered its position with regard to
Horizon und that, instead of wanting us to proceed with the national roll-out of the
computerised nctwork based on the Payment Card ~ which we have been planning to do
this sammer — the Government wishes us to contract simply for the supply of the core
Horizon platform as a tumkey contract (with on-going operational support) rather then a
PFI. Furthermore, it has been suggested that the existing PPP between TCL and The
Post Office might be developed to look at the business case (and downstream.
opportunitics) for network banking and Modern Government services.
J cannot pretend that 1 am not disappointed that you were unable to proceed with Option
Bl. However, as a businessman, I have to accept that my customers’ requirement has
changed. As Chief Executive of ICL, I have a duty to my Board, my shareholder
Fujitsu Limited) and tw my people to try to work out a solution with the Goverment to
protect ICL's (and Fujitsu's) interests.
However, I am not prepared to be party to living a lic. I cannot pretend any longer that
it is “business as usual” with regard to this project; not least to the onc thousand or so
people in 1CL, and our subcontractors, who have been working flat out to deliver
Horizon.
Therefore, I am setting out a timetable with the intention of resolving this once and for
all. I have discussed this with Steve Robson at the Treasury, but it is important that
Ministers give him the support and authority necessary to reach a conclusion in the
time-scale. I am also recommending this timetable of action to my Board this
aflemoon:-
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\
BA/POCL: ICL OFFER OF 13 MAY 1999
I
}
Summary: The price of ICL’s offer is considerably higher than we assumed in our I
modelling of B3, with the payments very heavily front-loaded. The NPV of the 4
offer is significantly worse than termination. In addition, we are concerned at }
some contractual issues. We have prepared a counter offer which would involve I
scaling back the NPV for ICL, transferring risk back to ICL and introducing more
conditionality to allow further scrutiny of the contracts.
The offer
The offer from ICL takes the form of a draft letter for a Government Minister to
send to them, enclosing documentation of what the deal means in contractual terms
by reference to the earlier contracts for the benefit payment card and the heads of
agreement for B1. Signing the letter as it stands would represent an unconditional
commitment.
Is the deal worth doing?
2. If Ministers do this deal, their decision will be scrutinised very carefully by
outside commentators and by the NAO. The key questions that Ministers need to
consider are: does it make commercial sense for POCL? Is the contract
satisfactory? And is the price reasonable?
Does it make commercial sense for POCL?
3. For POCL, the key commercial issue is the funding gap, which for them is
around £1.2-1.3 billion NPV compared to Option A (though much of this is
accounted for by reduced payments from DSS). This funding gap dwarfs all other
commercial issues for POCL. It is similar for termination.
4. POCL believe the Horizon hardware and software is probably sub-optimal
as the platform for providing network banking and Modern Government services,
but would need several months’ work to have a clearer view. They are therefore
unable to take a view on whether the Horizon hardware and software is preferable
to the system they might procure following termination.
Is the contract satisfactory?
5. ICL are insisting that this contract, involving the commitment of many
hundreds of £ millions for five years ahead, be signed within 24 hours of having
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handed it to us (yesterday ev
By ening). We strongly advise that any agreement be
made conditional on agreein;
2 detailed contractual terms over (say) the next three
months. This would give reasonable time for proper scrutiny of what are
complicated documents, It would avoid a situation in which we have an
unconditional commitment to proceed when unforeseen and unreasonable
Tequirements might be demanded by ICL in drawing up detailed contracts.
6. There are a number of contractual issues which in any case are not
satisfactory. ICL have attempted to shift a number of risks from them back onto
the public sector, for example, under this proposal, payments for the hardware
would not be dependent on it performing satisfactorily. We will need to ensure
that any counter offer (see recommendation below) addresses these points.
Is the price reasonable?
7. There are two ways to consider the price:
- how it compares with what we regarded as a reasonable price for B3 in out
modelling,
- how it compares with the termination option.
Compared with B3
8. The attached table illustrates both comparisons.
OF
It shows that, compared to our modelled B3, the offer is £320 million worse
in NPV terms. This is because:
- under options A and B1, ICL were prepared to accept an overall NPV loss
of £126 million. They are now demanding a return of £110 million NPV (ie
an improvement of £226 million) compared with the cost numbers they have
provided to us previously (under an earlier option called BO);
- and the remaining £80 million flows from the fact that the current offer
does not include the provision by ICL of network banking services. The
NPV assumes POCL buy these services from someone other than ICL - so
ICL do not receive any net contribution (profit) from network banking.
They therefore have to increase their prices on the services they are
providing to compensate.
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OMpared to ‘ermination, the offer “RAIN looks poor Value for m,
z loney,
M Whe key inne for Option c 16 the like
Thin Partly depends on the approa
Solicitor adyi 5
ely outcome of a ten
Mination *tlement
n. Treasury
Bree) that there is some advanta
PC contracts, Thi
formal terms th } Chto “ons. -
' ne . o
otherwise ackne tm the contracts at the original Price.
Vis ts the formal back CL and the Public sector parties
would be encouraged 1 Consider terms of Settlement as wel]
48 Working out the ord he contracts, If ICL purport to carry
on performing the of formal termination
under the contracts
12. Under termination, it is difficult
ASSES, al this stage, the 5
lo asses:
cttlement cost, If 1C
Sector parties have termi
8 the outcome of any litigation or to
Successfully claim that the public
nated the contracts for thei
on them could be ag Much as £330 million. At the other extreme BA and POCL
could recover damages for ICL's breach up to £200 million. It is likely that the
public sector Parties would be liable for some dama;
Present modelling is a damg
with views of ‘Treasury Sol;
ages lability of £150 mi
icitor
13,
‘The table shows that, on
POCL of a comparable off the
Move to ACT fr
fom 2003, has an NPV some
‘The offer is £400 million worse than termi
F Own convenience, the liability
this basis, termination, followed by purchase by
shelf automation/network banking technology, and a
£200 million better than the ICL offer.
nation followed by ACT from 2001.
Conclusion
14. The fundamental drivers for ICL/Fujitsu are to get rid of most if not all of
the pri
oVvision in their accounts, They therefore need a contract that is suf! pen
‘unconditional to satisfy their auditors, and with sufficient up front payment to
cover the provision.
15.
a "
As indicated above we would not recommend signing the ae its
ithout some changes to the terms and with sufficient conditionality to
withor s to th
proper scrutiny in the coming months.
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16 We also do not believe the current offer represents value for money,
compared with what we regarded as a reasonable price for B3, or compared with
termination
17.
We are preparing a counter offer, which would have the following features:
- a £270 million improvement in the NPV for the public sector. This could
be justified in terms of the extra profit ICL are now demanding, and/or on
the grounds that the public sector would be bearing additional risk under this
offer. It can also be justified in terms of making the deal better than at least
the more costly form of termination,
- reprofiling of the cash flow, so as to spread it more evenly over the life of
the contract,
- greater conditionality, to allow change in the light of further scrutiny,
- transferring risk back to ICL.
18. We think it unlikely this would be acceptable to ICL. We might want to fall
back a little from this position (particularly on the NPV) in negotiation. But the
bottom line should be no worse than the NPV for termination - it would be hard to
defend a deal which represents worse value for money than what the public sector
could achieve by going elsewhere. We would be exposed by the fact that the
counter offer already has an NPV £160 million worse than termination followed by
moves to ACT from 2001.
19. Viewed against the Prime Minister’s requirements (Jeremy Heywood’s letter
of 11 May) - see annex B:
- accepting the offer would avoid a row with the sub-postmaster lobby, avoid
putting ICL’s future in jeopardy, but we do not believe it offers value for
money so would be hard to defend with the PAC;
- termination might be difficult to present with the sub-posumasters,
depending on the termination settlement, it would have implications for ICL,
but is unlikely to put their whole future at risk; but would be defensible on
value for money grounds,
- the best approach would be to put a counter offer - if accepted, it would
satisfy all the PM’s requirements. The vfm test would depend on Ministers
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deciding that, as a matter of policy, they were not prepared to start a move to
ACT before 2003.
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