POL00028452 - Investment Appraisal Commentary for BA/POCL Automation (MP(96)42A)
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MP(96)42A INVESTMENT APPRAISAL COMMENTARY
BA/POCL AUTOMATION
GH rcksround This submission seeks authorisation to enter into an 8 year contract , 4
(up to 3 years to develop and implement, followed by a 5-year contract)
with one of three shortlisted Service Providers (referred to as Tom, Dick
and Harry for confidentiality), for the provision of automation of all
post offices, and a new card-based benefit encashment service, and
provide ‘in principle’ approval for NRR expenditure up to a maximum of
£10.0m for the implementation of the programme.
This follows on from MaPEC approval in March 1995, MP95/20, for
planning costs of £5.7m for POCL’s share of a joint development study
with BA, amended in February 1996, MP96/24, to include a
development test centre, contained within the initial authority.
Acceptance of a bid, following final evaluation of the revised bids, will
be conditional upon the case delivering a positive NPV over the base
case, and the risk to POCL remaining at an acceptable level.
Key Issues Assumptions
The comparative advantage of the PFI is predicated on the key
assumptions relating to the base case. Whilst considerable effort has
been expended, utilising Coopers & Lybrand, in validating base case
assumptions, they are only that, and therefore the delivery of the
comparative NPV benefits are based on the robustness of the two sets
of assumptions. The methodology has been comparably applied to both
scenarios i.e. it is acceptable that there is no more risk inbuilt into the
PFI, than the base case.
Any errors in the assumptions for the base case, do have a knock-on
effect on the PFI case costings. However the interrelationship has not
been tested, and remaii ji int: Likewise, it is probable
at many of the business assumptions used, are interrelated, and
that delivery or non-delivery will impact on other parts of the business.
It is therefore critical to monitor and track benefits and costs through a
benefits management plan to identify both the incremental and inter-
related charges. The base case has been prepared as the ‘do nothing’
option, and is based on commercial objectives which form part of
POCL’s business plan.
The nature of the PFI contract means that POCL will only pay for the
system as it uses it, reducing revenue/cost risk.
Whilst there will be a floor price’ in the contract with BA, and
Automation derisks the propensity for BA to bring forward and
prioritise, in our view, Automated Credit Transfers remains a live risk.
There remains some uncertainty on the impact, of the proposal on other
I business mainly RM. Any inter-business issues should be resolved
wee 020 book I a priority, and the business effects quantified, but should not be
sw allowed to cloud the overall position at PO level.
Walom Congo Technical
al po This is a major transformational project for the Post Office which will
have a wider impact than just on POCL. It is therefore important that
the project has an appropriate technology configuration, and that its
wider impacts are clearly understood.
The Technical Concurrence does not address this wider issue, but
places a condition that a formal process is established with the
selected supplier to ensure that long term systems development
remains consistent with PO strategy, and that safeguards are
introduced to ensure that POCL is not prejudiced from taking
advantage of standard software upgrades in the future without formal
lagreement. It is unclear as to what safeguards have been built into the
contractual discussions held to date, and therefore this is addressed in
the Recommended Conditions.
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Of the 3 bids, the preferred bid from a financial perspective, Dick, is
stated to have a significantly higher technical risk associated with a
bespoke development around an innovative messaging technology,
providing low commonality with industry standard retail solutions,
which may preclude retail best practice in the future. The proprietary
nature of this solution causes concern, and the introduction of new
applications may be more difficult.
Automation
The majority (80%) of product development opportunities in POCL’s
business plan proposals require, or will be enhanced by, automation.
The delivery of Counters automation strategy is dependent on the
successful implementation of discrete, but interrelated projects:
Transaction Information Processing (TIP) and Distribution Systems
Project (DSP). TIP is proceeding on the basis that BA/POCL will go
ahead. DSP is standalone, but delivers incremental benefits from
automation. Both TIP and DSP are at an early stage of development.
TIP goes hand-in-hand with BA/POCL automation. Unfortunately the
comparative timetables are not compatible, and it has therefore not
been possible to specify a ‘Cost Benefit Analysis’ for TIP. However
BA/POCL is presented on the basis that TIP may not go ahead, and
that all the costs necessary to deliver BA/POCL functionality are
included, as well as those benefits deliverable by BA/POCL alone.
Benefits have therefore been apportioned to BA/POCL, TIP and DSP.
All 3 projects have signed up to this split. The BA/POCL case therefore
excludes incremental benefits expected to be derived from automation,
but delivered under TIP.
The PFI service provider provides a discipline that Counters, if they
were to progress with automation themselves, may find difficult to
match, PFI takes out a major risk - project implementation - or, at
least, compensates for failure.
Financials
Sunk costs to date of £5.4m, have been included in the cashflows. It is
clear that the PFI delivers at best marginal direct financial benefits on
any given set of assumptions. However automation itself provides a
platform for Counters to exploit, and this may place a considerable
challenge on the retail network to deliver incremental benefits from the
enabler of automation.
The financials, prepared on an 8-year project life, have year 0
designated as 1995/96. Restructuring this to 1996/97, has negligible
NPV impact on the ‘best’ case NPV of £45m (Dick).
To achieve its marginal return, the business case assumes new
business of £77m in NPV terms over the project life. Failure to achieve
this, equates to an average £15'%4m p.a. adverse impact in cash flow
terms. It is therefore imperative that at a minimum, the forecast level
of new business benefit has to be achieved if the project is to return a
broadly neutral financial return; benefits from the previous aborted
Counters Automation, dissipated during a lengthy development phase.
NRR of £10.0m for project implementation, principally over the first 3
years, is included (over and above base case costs), and we assume
includes ‘decommissioning’ of the project team. This should be
readdressed as to whether there is any headroom for cost reductions,
or whether some costs would be able to be absorbed in the concession.
The impact of VAT has been considered by Ernst & Young, and
included within calculations. Group Taxation have had restricted
involvement in evaluating/reviewing the assumptions of the effect
upon the VAT recovery rate, but subject to changes to, and
applications of, VAT law, are of the opinion that the conclusions are
correct. The services generated under the contract will have the effect
of raising POCL’s VAT recovery rate from 22% to 26%.
ay
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The fact that the cashflows have changed significantly during final
evaluation, suggests a degree of caution needs to be placed on the final
NPVs, and that the these remain volatile to changes in assumptions.
e S 0) I The comment that the Treasury regards the deal as too beneficial to
+ POCL, runs the risk that it may revisit Counters targets in the future.
Contractual
Ernst & Young have reviewed the contracts issued, and concluded that
it is unlikely that this procurement will be on balance sheet. A
conclusive statement however cannot be given until the final contracts
are agreed.
9 Not only is it important to monitor the PFI contract, but given the need
Show , to re-tender the concession, the performance against the contract will
form the base on which to evaluate retendering.
The option of PO procurement appears not to be feasible:
¢ the financials are no better than the best bid, but at greater risks to
the Post Office;
¢ BAare strongly against PO funding and owning the system.
Conclusions The risks to not proceeding with the PFI option, are viewed as greater
to Counters infrastructure, than the risks of not proceeding at all.
These are inherent risks to POCL of not providing automation, and
these outweigh downside risks built into the business assumptions.
Key for POCL is to use the automation platform as an enabler to
generate other business benefits.
The interrelationships to other projects, TIP and DSP, are therefore
key, and will need to be stringently ringfenced to ensure they deliver
incremental benefits.
The risk of contract variation during the contract, when finalised, is
unclear, and therefore potential future benefits could dissipate.
Sponsors should aim to minimise scope for renegotiation with both the
Concessionaire and BA, and any contractual risk remaining will
require ongoing stringent management.
Recommended Conditions ¢ The technical concurrence is unable to be definitive and final at this
stage, and therefore there is a requirement to ensure that the
proposed technical solution of the chosen supplier is signed off by
an unconditional TCC prior to signing final contracts, as to the
supplier working within the overall Post Office IS strategy
(applications and infrastructure), and that POCL is not precluded
from taking advantage of standard software upgrades in the future;
* Once the contract has been agreed/awarded, the financials should
be re-submitted to the Secretariat, with significant variances
explained, for noting at MaPEC, which should form the basis of
future monitoring; and an annual report back thereafter;
The individual assumptions detailed in both the base and PFI cases
must be tracked and reported through a benefits management plan,
and continued throughout the contract; CEC
A_programme board should be set_up to oversee all future retail 6
initiatives, This must ensure that benefits/costs are incrementally QulrerI
identified to that initiative, and do not become subsumed within
this project.
The risk management plan must include provision for identification,
and avoidance of, potential contract variations.
Recommendation Subject to the above conditions, and Board endorsement, the PFI
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MP(96)42B(i) SUMMARY OF PROJECT INFORMATION ‘
ENERAL .
oject Title: BA/POCL AUTOMATION
Project Sponsor: Richard Dykes/Stuart Sweetman, Managing Director
Project Controller: Paul Rich, Financial Markets Business Centre Director
NPV im Base Case PFI PO PO
Automation Procurement Procurement
(preferred single 4 yearly
option) replacement replacement
Income
Benefits Agency (inc SSA) 2119 2119 2069 2069
Volume Change (203) 717 77 77
4 Price Change (196) 107 107 107
Sub Total 1720 2303 2253 2253
DSS Girocheques 325 325 325 325
Volume Change (21) (188) (188) (188)
Price Change 6 2 2 2
Sub Total 310 139 139 139
Other Clients existing & new = 77 77 77
Savings on existing = 40 40 40
automation
Sub Total — 117 117 117
Expenditure
Benefits Agency (1889) (2112) (2112) (2112)
Girobank (297) (140) (140) (140)
Time Increases (15) (15) (15)
Card Issue/back office 73 73 73
Training (3) (23) (23)
Programme costs (sunk) (4) (5) (5) (5)
Programme costs (future) (25) (25) (25)
Fraud (1) a = =
Sub Total NPV before (161). 332 262 262
supplier charges & risk
Supplier Charges/Risk (122) (191)
System Charges BES (145) aa =
POCL (220)
Other (36) (177) (177)
VAT. -— (27)
Total NPV (161) (96) (37) (106)
Base Tom Dick * Harry PO PO
Case single 4 yearly
Sub Total NPV (161) 330 332 332 262 262
before supplier charges & risk
System Charges --- “= =< (122) (191)
BES (145) I (145) I (145) — -
POCL (236) (220) (233)
Other (36) (36) (36) (177) (177)
VAT : (27) (27) (27) = ==)
Total NPV before risk (114) (96) (109) (37) (106)
Assesment of risk (17) (20) (17) (74) (74)
Total NPV (161) (131) (116) (126) (111) (180)
ba Preferred option