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FACSIVOLE
TO: ' Pout Qen
FAX NO. Lu GRO
DATE: I 19 I aS
FROM:: ‘Richard Chiistou,
_ ICL :
_ 26 Finsbury Square
London EC2A DS I
: Tel: : GRO
MESSAGE:
: Pleoae: soe thes atlachesh
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i
13" October 1998
'
Mr. Graham Corbett, [ .
HM Treasury, . an /)
Parliament Street,
London,
SW1P 3AG
Propose fay Forwari rogramme
L enclose ICL’s proposals on the way forward for the BA/POCL Programme.
This is based upon the discussions and presentation we made to you last week, °
and continues. to be our position in resolving the commercial and programme
issues faced by the programme.
Yours sincerely,
Ce: « Graharn Corbett, BA
>> PRich, ROCL.
R Christou
Director
Commercial & Legal Affaire
26 Finsbury Square
London EC24.1DS.
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ICL PATHWAY
Proposed Way Forward for the BA/POCL Programme
;Due to the way in which the contract has been handled by the sponsors, especially the
‘Benefits Agency, ICL is faced with cver increasing costs, declining volume in full
:operation, no certainty about when full operation will begin and the consequent
“impossibility of financivg the completion of the programme without a thorough
txestructuring of the original contract. It is completely inconsistent with the PEI
ieoncept to argue, as Graham Corbett has done, that ICL should write off its past costs
tand look only to the future.’ Under PFI. the contractor’s expenditure on the design,
: build and finance phases should be remunerated during the operational phase. In the
{discussions with Gratiam Corbett, ICL has put forward a number of proposals for
isolving the problems. This paper sets out the ICL position.
In parallel with the HM Treasury review, ICL has engaged in confidential discussions
! with the Post Office to explore proposals in which the Post Office would take a 50%
} less one share ) equity stake in ICL Pathway. Athough such a proposal has merits in
its own right, it’ could also provide the key to making possible the next stage of
i funding for the programme provided that an acceptable commercial deal can be *
‘agreed. The essential points for the equity proposal are described in the attached note
: by Sir Michael Butler dated 9 October. :
2. Proposal Objectives
! ICL believes any settlement must provide a fair way forward for all parties, and must
! provide ICL Pathway with a fair chance to at least break-even over the contract. The
committed funding by ICL to date stands at some £250m, with the expectation that a
- further £250m of funds will be necded to complete the programme. Whereas
* originally it would have been reasonable to expect to put non-recourse funding in
* place after ‘full acceptance in July 1997, we are still a very long way from reaching a
- position where this would bo ‘possible. In all the circumstances, ICL does not
consider it reasonable to try to make a distinction between the past and the future, as-
- , Graham Corbett has soughtto do.
3. Components of the Solution
F In addition to the equity proposition there are four key components for an acceptable
solution; contract term, contingency arrangements for known and future: risks, :
achievement of contractual acceptance, and appropriate pricing arrangements. Each
component has elements of flexibility, which taken together can provide an acceptable
+ resolution for ICL. Pathway. This paper describes one such combination.
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A. Contract Term
The sponsors have indicated that they. may be prepared to consider a contract
- ‘extension with ICL Pathway to end March 2007 for BA and to end March 2009 for
!POCL. BA state that they would migrate all non- ACT benefit payments to full ACT
i by the end of their contract, on 2 20%, 40%, 40% basis, starting in fiscal ycar 2004/5.
This amounts to maintaining the period of full operation in which ICL receives
* revenues at five years but delivers a sharp decline in volumes within that period.
* POCL’s offer to extend the contract to 2009 is much more helpful, especially if POCL
» “and ICL Pathway form a dynamic partnership to open up new streams of revenue.
: Furthermore POCL have indicated that they may be prepared to fund the cssential
+ equipment upgrades and replacements required in the post office network in 2006.
5. Contingencies for known and future risks
” Discussions between the parties have highlighted and helped define the outstanding
: differences on the implementation plan and its detailed timetable for project
: completion. The major areas requiring contingency arrangements are:
- programme risks leading to delay
- contractual acceptance including process and sign off
- BA and POCL business volumes
+ fraud risk +
- service level agreement penalties
- programmic costs
: Although the above contingencies are being further refined between the partics [CL
Pathway has included a contingency of £100m (£60m in NPV terms) in its business
case to cover the likely outcome on these risks, This figure could double if the
" acceptance issuc referred to below is not resolved.
I We recognize, however, that all parties share.a mutual interest in mitigating and
: preventing: such risks materializing. ICL Pathway has offered the sponsors the
: principles of an incentive plan whereby if specified contingencies can be avoided, the
_ associated cost savings can be shared on a 50/50 basis. This would offer the sponsors
the prospect of cost reductions, and ICL Pathway the opportunity for a modest retum
on its investment in the programme. The main intent, however, is to incentivise all
* parties to work together to-effect a prompt delivery of the benefits arising from the
: programme. This has not worked well in the past. 5 %
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6. Contractunl acceptance
: The speed of the acceptance process has becn highlighted as probably the most critical
programme risk. Given our experience since 1996, any revised programme must give
. us assurance that the contract will not be terminated at some date in the second half of
* 1999 ona relatively minor technical point. :
ICL proposes that programme acceptance must be managed in a staged approach, with
cach stage having its own, self contained, acceptance arrangements. Deferred, or
_ ‘conditional acceptance, with termination rights preserved for later stages is
unreasonable. . .
+ We recommend that acceptance of the first stage scheduled to go forward for national
; Toll-out in July 1999 is handled as part of the HM Treasury review process and is
: completed by the end of December 1998. .
: The BA components of this first stage, covering use of the Payment Card for Child
+ Benefit, and: the Order Book Control Service have been subjected to extensive joint -
testing and have had operational exposure in over 200 post offices for very many
months and are known to work woll for staff and customers alike. There is no reason
+ to delay acceptance.
*. The sooner full acceptance is achieved the better since non-recourse funding depends
on it,
7 Pricing Arrangements
Given the’BA’s desire to get away from the use of the Payment Card as soon as
possible, and the necd ‘for prices to bear some of the burden of the increased costs.
JCL have proposed that the contracted prices set in May 1996 should rise in line with
- inflation throughout the contract period. This effectively offers the sponsors‘a fixed
price contract in real terms.
It would be possible to construct a payment mechanism for BA based upon aa annual
. fee structure, agreed in advance, and based upon BA's best view of volumes and their
: ACT migration plan, This would provide some flexibility to the BA in the’speed and
* choice of benefits to migrate to the Payment Card, prior.to the final migration to ACT.
: It would also provide ICI, Pathway with a predictable revenue stream.
We sce the arraugements for POCL continuing as at present with the only key change
. being that the banking volumes are underwritten at 90% of best forecast volumes.
.. This reflects the fact that achievement of such business rests exclusively with the
. business drive within POCL.
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8.. Summary and next sfeps
So far Graham Corbett and the sponsors have based their positions on ICL’s
* acceptance of writing off.its past expenditure as a Joss. Moreover, given the risks, the
2 prospects of profits in the future appear dim. This is unacceptable in principle for a
_ PEI contract and it would make it impossible to sccure the financing necessary to
“complete the programme. * We submit that ministers now need to agree a framework
which would make restructuring of this PFI contract a reasonable deal for ICL and
+: give Graham Corbett or some senior government representative a mandate to settle the _
! problems fast on a fair basis.
+ Richard Christou
13% October 1998
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ICL PATHWAY
© ICL have no wish to cut across Graham Corbett's efforts to promote a solution
to the problems in the BA/POCL programme. We will therefore concentrate
exclusively on the ICL proposal for the Post Office to take an equity stake in
JCL Pathway. Though it could provide the key to unlock the programme’s
problems, the proposal has merits in its own right.
© ICL is not aware of the Secretary of State’s thinking on the future of the Post
Office. But whatever the outcome of his review, it seems to us that the Post
Office and Post Office Counters Ltd (POCL) in particular, will need to be
enabled to operate as a modern, entrepreneurial, commercial business if its
long-term future is to be assured,
« Because the [CL Pathway system has been designed with Smart Cards in mind,
it can be developed to serve the Government's needs for more user-friendly
and cost-effective dealing with the citizen. If the Post Office has a major
equity stake in ICL Pathway, it will be better placed to help in this process as
well as being able to increase its earnings, assuring the future of the POCL
countrywide network. .
*“e POCL needs a world-class IT system for many of its operations. ICL Pathway
could help to re-engineer its business processes to make it more comptiitive.
ICL would be ready to ‘contribute its own skills in‘this field, into the joint
venture.
¢ POCL and ICL working together would make a powerful team which could
exploit other new commercial opportunities, including retail banking and
export initiatives for postal systems.
© ICL believes that during the duration of the contract (as agreed in the current
negotiations) the present ICL Pathway management shoujd remain in place.
But ICL would, hope’ that the Post Office would but 50% (less one) of the
_ shares; .and would, of course, welcome Post Office representation on its board;
and would be open to proposals for changes in management structure or
ownership thereafter. .
. * ICL wishes to take it as an assumption that the present negotiations will
succced. But it needs to point out that the consequences of failure would leave
POCL very exposed, without a modem IT infrastructure. :
"Sir Michael Butler
9* October 1998
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BESl
DSS/BA/POCL OBJECTIVES
¢ Fair way forward for all parties
* Provides ICL Pathway with:
¢ a fair chance to make a modest return on future investment
required to complete the project;
¢ a fundable solution
* Secure safe delivery of the project, to agreed milestones
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