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CHIEF SECRETARY
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PETER SCHOFIELD
5 May 1999
Chancellor
Economic Secretary
Sir Andrew Turnbull
Steve Robson
Harry Bush
John Gieve
Adam Sharples
Mike Williams
Alan Mawdsley
Sarah Mullen
Robert Ricks
Ed Balls
Shriti Vadera
Spencer Livermore
Your meeting with Alistair Darling, Stephen Byers and Lord
Falconer this evening.
Objective: To get colleagues to agree to drop Option B1 on value for
money grounds.
POCL and DTI have not come up with
anything that would bridge the affordability gap since your last
Ministerial meeting.
Developments since the last meeting
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2. The key paper for the meeting is attached. This has been prepared
by Sarah Mullen and cleared with DTI and DSS. The other Ministers also
have this.
3. The paper sets out the developments since your meeting of 21 April.
Briefly, these are that:
- on Option A, ICL have now withdrawn their offer of 18 December.
This confirms that Option A is no longer a viable option for Ministers;
- on Option B1, POCL and DTI have not come up with anything that
would bridge the value for money gap (£870 million compared with
Option A or some £400-500 million compared with termination). All
they have come up with are ways of financing the gap, which I
understand Stephen Byers’ raised with you recently, neither of which
look attractive (see Annex A);
- we have worked up an Option B3, along the lines set out in our last
report and proposed by Alistair Darling at the last meeting, in which
POCL would buy the automation platform from ICL, but then move
straight to a network banking strategy without either the benefit
payment card or the POCL bank. This option is estimated to have a
similar NPV to the non-ICL termination option (Option C) - £350
million worse than Option A, but £500 million better than Option B1.
It therefore looks attractive if it could be negotiated. However, both
POCL and ICL have indicated they would not be interested in it (at
least while Option B1 remains on the table).
Views of other Ministers
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4. We expect both Stephen Byers and Lord Falconer to press for Option
B1. We expect them to make the following points:
The figure of £870 million for the affordability gap is disingenuous,
since it compares Option B1 with Option A which is no longer viable.
and
Option B1 still has a positive NPV (i.e. the savings exceed the costs
compared with the “do nothing” option of continuing with paper-
based systems).
But the public spending baselines were based on the savings which would
have emerged under Option A. So the Treasury would have to find an
additional £870 million, compared to an estimated additional £350 million
on Option B3;
The cost over the next 3 years of Option B1 is similar to that for B3 or
C. We can sort out the additional costs of Option B1 for 2002-03
onwards in the next CSR.
For all 3 options, the delay to moving away from paper-based systems of
paying benefits compared to Option A means there is a cashflow hit during
the CSR years. We will have to find some way of meeting the costs (see
Annex A).
But the decision between the options should be based on the costs over
the whole life of the project. Option B1 is much more expensive than any
of the alternatives over that time frame.
Option B1 is the only option that delivers Modern Government
services. It has the potential to deliver huge savings to Government
and large revenues to POCL.
- But there are any number of potential providers of Modern
Government services. And the Cabinet Office policy is to leave it to
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individual Government departments to decide who to contract with to
provide these services - there is no cross-Government strategy to
focus on a single provider;
- In order for the Post Office to compete as a provider, they need an
automation platform. That is implied under all the options;
- Accept that Option B1 is likely to give POCL and ICL a major boost
compared to other potential providers of these services - they would
have the first smartcard in wide circulation. But this would be at great
cost to the Exchequer. And so far, neither POCL nor ICL have been
prepared to commit to what this might mean in terms of additional
revenue. We have asked them to reconsider this view this afternoon.
We are unclear what Alistair Darling’s views are likely to be. There are
signs that he may push for either of the termination options (option C or B3
- the one he originally suggested). But now that Option A is firmly off the
table, he should be satisfied with any of the alternatives.
What line should you push for?
5. I The value for money analysis provides a clear steer in favour of
options B3 or Option C which have similar NPVs:
- Option B3 has the advantage that we retrieve from the project the
automation platform for the Post Office. There would be a
presentational advantage if a deal could be done with ICL on this
before termination of the benefits payment card became public,
although ICL would be likely to exert a heavy price in return. We
might get better value if we reached this option via termination;
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- Option C would be a non-ICL solution. It might allow the PO to buy
an IT system which better fit their long term network banking
strategy, but much greater uncertainty, and hence difficult
presentational issues (e.g. with subpostmasters), in the meantime.
6. We advise you to argue strongly against Option B1 as it stands. But
we have been considering what could be done to Option B1 to make it
more acceptable. The key is whether there are additional revenues from
modern Government which could be realised under option B1 compared to
option A or any of the other options, and whether we can reduce the risk
being borne by the public sector. This might involve:
(i) I across-Government strategy for Modern Government services
which focussed on POCL as the main provider, given in
particular their unique geographical and social reach. We have
this afternoon asked POCL and ICL for a view as to what such
a strategy could mean in terms of additional value. But note
that this approach flies in the face of the existing modern
Government strategy, and is likely to be resisted by some of
the main potential customers in Government;
(ii) trying to bring greater dynamism into POCL’s management
culture. It is hard to imagine anything achieving this short of
(iii) below;
(iii) introduction of a strategic partner on a risk sharing basis
(preferably with an equity interest). But it is hard to imagine
anyone wanting to make such an investment, even if a minority
share sale of POCL was a realistic option politically. ICL have
said they might be interested in coming in once the initial
investment has been made by the Government.
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PETER SCHOFIELD
PEP
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— I
ANNEX A
How would we finance the affordability gap?
Given the affordability gap for options B1, B3 or C compared to the public
expenditure baselines, you asked for advice on how this might be financed.
I understand you spoke to Stephen Byers about this recently.
The net costs of any of these options would fall to the Post Office (and
probably also DSS), who would pay for it from the following sources:
- first, from the savings which would be received by the DSS
(compared to Option A) which we would recycle to the Post Office.
But this would leave the affordability gap worth some £870 million
NPV for option B1 or around £350-500 million for options B3 and C.
This would be funded by the other two sources;
- second, by reduced cash flow for the Post Office (or potentially
greater borrowing from the Government in the form of the National
Loans Fund). We would relax the Post Office’s dividend regime/EFL
to compensate, thus avoiding this damaging the rest of the business.
Because the PO is a self-financing public corporation, this relaxation
would hit AME rather than DEL;
- third, some of the cost of termination (under option C at least) might
fall to the DSS. This could cost up to £150 million and would be a hit
to the DEL Reserve.
However, you also asked us to consider two alternative sources for
meeting the affordability gap proposed by Stephen Byers:
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- additional, commercial borrowing by the PO. But borrowing by the
PO from whatever source scores within AME. The only difference is
that commercial borrowing costs the Exchequer more, since the
interest rate is higher than the Government can obtain by issuing
gilts;
- whether we might delay by 3 years the reduction of the PO
monopoly from £1 to 50p. DTI are currently anticipating that this
reduction should take place next April (although we have been
suggesting you press for this reduction to be at the time the White
Paper is published). We are not yet clear what DTI believe this delay
would save the Post Office in revenue.
We would strongly advise you to oppose any delay to the reduction in the
monopoly. This is a key element of the PO reforms. Indeed, with the
decision last December not to pursue any form of share sale for the PO, it
is the only way we have left to inject additional disciplines on the PO to
mirror the commercial freedoms they have been given. We are concerned
that it would leave Government policy on the PO in disarray.
Our strong view is that you should decide on the options according to the
value for money (i.e. the NPV) case. Decisions on funding should flow
from this decision, rather than determine it.
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