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POCL AND THE ICL PATHWAY DEAL
2
be
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Introduction
I have been asked, as a member of the POCL team not closely involved
with recent negotiations, to “stand back” from the deal_and review it (as
independently as possible for a CEC member) to confirm that the chosen
direction remains sensible, In this I have been assisted by Jenny Cole and
Hilary Stewart, with support aiso from Tim Brown and Bill Lavery: I am
especially indebted to Jenny, for carrying the work forward assiduously during
my period of sick leave.. Keith Baines and Liz Blackburn provided financial
figures to tight deadlines, and this was much appreciated. I am also deeply
indebted to Joan McNamara for her patience in typing this report.
T have aimed to conduct this review within the broader context of POCL
business strategy. I have summarised my interpretation of the strategic issues
in Appendix A, and that analysis has guided the report.
Some views are attributed to third parties. These have not been obtained
directly: the impressions were gained in interviews with POCL people and
therefore reflect a collective understanding within the business.
The methodology adopted was a combination of review of documentation and
series of interviews with POCL personnel. Appendices B to E record the main
points of the evidence collected in this process. Appendix F includes a list of
interviewees and the team’s original brainstorm of the lines of enquiry the task
would require.
Findings of the Review
Overview
5
aL
{am satisfied that those directly involved in negotiations genuinely believe
that it is better to proceed with Horizon on the renegotiated terms than to
abort. It is. however, a measured view rather than an enthusiastic one,
recognising that proceeding will bring formidable challenges.
Negotiations appear to have been informed at all stages by proper financial
and strategic analysis, including the agreement of clear negotiating authority,
and professional advice has been taken. The Post Office is therefore able to
Justify its due diligence in the matter.
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a The negotiations were also subject to assurance review at appropriate stages,
and contingency plans were prepared against failure.
24° The conclusion of negotiations with a firm decision to proceed should put an
end to a protracted period of uncertainty. permitting a fresh start with renewed
focus not only for the Horizon project but for the POCL business.
Unfortunately, many uncertainties, unanswered questions and doubts about the
future remain, so that the benefits of such a fresh start seem unlikely to be
obtained without a concerted, focused and single minded leadership effort by
both POCL and ICL teams to emphasise the positive.
2.5
5 Even on the basis of protecting benefit payments, the go/no go de
extremely finely balanced, with neither option being fully satisfacto
POCL. Proceeding means full commitment to an automation route and a
partner. neither of which are ideal in the context of realising the new Counters
vision. But not proceeding would so delay the building of automated
capability, and undermine the business’ credibility internally and externally, as
to put the vision at significant risk of becoming undeliverable.
Several senior managers, close to the project, but not principal negotiators,
whose judgement I respect, express significant reservations about the risks of
proceeding. These centre on their continuing doubt about the ability of ICL to
deliver a satisfactory product; the absence of transparency in the PFI contract:
th ‘at ICL’s financial fragility will endure throughout the project, with
the possibility of repeated claims on The Post Office for extra contributions
(which, by then having no alternative, it will be unable to resist); and doubts
about POCL’s own ability to give it the focus essential for success,
Observation of the track record so far offers reasonable foundation for such
Views,
no
Mo
hile much effort has been devoted to understanding the commercial and
financial implications of the deal, the supporting Heads of Agreement on
partnership with ICL were negotiated over a short period close to the
conclusion. I have found little evidence that the implications of this part
of the possible contract for POCL’s management and for The Post Office
have yet been fully and systematically reviewed. The implications may be
profound. For example, how heavily does the partnership agreement constrain
The Post Office from engaging in other collaborations in related areas? Is The
Post Office effectively constrained to a broadly current view of the future of
the counter network by its commitment to ICL, even if that were eventually
shown not to meet its shareholder value aspirations? And does ICL have
sufficient access to capital to be able to flind the proportion of investment in
new vision development which POCL needs to be provided by its partners for
the vision to be affordable? (1 understand that the Heads of Agreement have
technically lapsed, but write this on the basis that they would still be the basis
of proceeding if the deal proceeds.)
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On balance I agree that it remains right te press ahead with Horizon
despite the extra cost involved, because
~ itis financially better than terminating
~ the alternatives are at least as uncertain and no more attractive
~ it safeguards the immediate future of benefit payments at post offices
~ itmoves POCL to a card based technology, with the door left open to a
smartcard strategy later
~ the loss of credibility with key stakeholders (clients, agents, employees and
customers) associated with abandoning the project would be severe
~ termination will involve litigation and the diversion of much management
effort to limit the financial impact, which will be strategically nugatory.
~ There are however two important caveats to this conclusion
a) I am assuming that the Post Office will be content that any
constraints - such as those trailed in the previous paragraph - which
the ICL partnership imposes on it are acceptable and do not affect
these benefits, but am not currently able to verify that.
b) If the deal is modified so as to limit or deny any of these benefits
my conclusion will need to be revisited, (for example if there is a
significant drawing back from the currently agreed levels of benefit
payment transactions or the use of cards, which undermines footfall
in the network.)
The financial context
28
Ned
The financial validity of the decision is critically dependent on the view taken
of the likely response of the Benefits Agency (BA) to the collapse of Horizon,
in particular of the speed at which BA would move to alternative payment
methods and withdraw conventional payments through post offices. Medium
term retention of current post office business is essential to support the
automation implementation. (Benefit payment is about a third, and through
footfall supports a further significant proportion of current counter volume.)
The negotiaiors take a pessimistic view of BA’s intention to take payments
away from post offices. (This supports their judgement that it is better to
proceed with Horizon so as to retain BA business.) That view appears to be
reasonably grounded in the observed behaviours and statements of BA and
DSS officials and Ministers.
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Itis important to recall that the business case for automati 's that it
would be a better outcome than not automating, not an absolutely good
outcome. The principal benefit of the original case was the retention of BA
business by contract A. Since contract A is in place. and that main benefit is
therefore flowing, even protracted delays to Horizon have appeared beneficial
in casework NPVs because the costs have been deferred.
This very large financial effect has overshadowed the potential damage to
POCL’s strategic capability through not having implemented the basic
infrastructure on the ground, and therefore not being able to move on to
consider strategic improvements. Although there is an assessment of new
non-benefit business attributable to automation, the financ model does not
attempt to assess the impact of delay to automation on existing clients’
propensity to defect. Thus there is an intuitive adverse effect of delay
(including “sunk” delays to Horizon) which does not appear in NPV
calculations at all, The financial casework does not evaluate POCL’s “fitness
to compete” as the def technique focuses only on measurable incrementalcash
flows.
The comparison of options has been done within the paradigm that a
nationwide network of post offices will and should exist. So long as the
outcome retains benefit payments at post offives by cards it preserves both the
medium term guarantee of customer footfall and loyalty and the “jumping off”
capability towards a transformed capability. The case for Horizon leads to the
maintenance of existing shareholder value, or slowing its decline, rather than
creating new value, (although this type of analysis is at too early stage to be
the basis of immediate decisions.) While the solution preserves strategic
capability this situation may be tolerable. Were any of that te be lost in any
variation of this deal it will expose the need to consider the option of not
automating at all.
Key financial parameters are summarised at Appendix B, including a
comparison of the key assumptions. They confirm that the deal has a better
NPV than terminating, but all options treat the position of existing clients
(except BA) equally, irrespective of the timing of the introduction of
automation. The sensitivity of the comparisons to the assumption about the
uming of ACT is high, but even if the termination assumption is very
pessimistic going ahead is still better.
Alternative options which promise continuing BA income levels but do not
guarantee the transaction footfall or investment in it (eg by having plastic
cards) may show overstated NPVs, unless the potential damage to the fabric
of the counter network is factored in to the calculation. (1 have not been asked
to review alternative options to the main deal, such as are currently receiving
political attention, but I wish to flag up that concern here.)
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21S A financial aspect which has not been fully evaluated is that the deal transfers
so much risk back to POCL that the Horizon assets will have to be on POCL’s
balance sheet. (See Annex 410 Appendix B.) It could lead auditors to the
view that the asset is “impaired” because the future revenue streams are
insufficient to support it - a result of the deal being better than the alternative
ohutely unexciting. “Impairment” could lead to a significant write-off
outcome would technically breach the clause in the
brief that requires the deal not to adversely impact POCL’s short
termi targets.
Working relationships
2.16 nee it has been the desire of BA to terminate the ICL contract and they have
been frustrated by the unwillingness of POCL to support them, there is a risk
sarial, may
ision to proceed. The importance of BA work to POCL
and its customers is such that it must be a major objective to ensure sound
relationships and maintain some kind of constructive partnership, across the
whole range of mutual dealings. From “outside” this does appear to be a
challenge. but those involved in negotiations believe that personal
relationships are or can be made satisfactory. Since BA and POCL have
different objectives, disagreement is at present inevitable. Once a decision is
niade it will be important for both parties to work together to ensure it is
effectively implemented.
2.17 A summary of BA issues identified during interviews is at Appendix C.
2.18 Itis equally erucial that a sound working relationship with [CL is maintained,
characterised by trust and openness. Over protracted negotiations both parties
will have been consciously seeking to protect themselves from the other's
failures. and from legal Hability, Given that there are stil] risks around the
delivery of Horizon there is still room for defensiveness about relative
responsibilities and the partnership will need to be wholehearted and proactive
in its commitment to delivery.
2.19 The deal with ICL gives them an expectation of being the Post Office’s
primary collaborator in developing markets associated with POCL’s new
vision. Work in other parts of the Post Office could be caught by this, and
needs to be co-ordinated appropriately. There is a need for clear Post Office
wide understanding of the scope and influence of the ICL relationship, shared
by all businesses and by ICL.
s arising during the interviews, concerning the ICL
ip is at Appendix D.
2.20 A summary of issu
Pathway relations!
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Focus within POCL
2.
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1
Issues identified in the course of the review in connection with Vision and
Strategy are at Appendix E.
During the last three months’ heavy commitment of activity (including
Horizon, new vision development, the budget and planning round) the CEC
and senior management have necessarily had to divide their labour. Directors
have been withdrawn for negotiations with ICL, BA and Government. Few
CEC meetings have been fully attended. Uncertainty about the new vision has
grown as development work has been undertaken and communication has been
held over. The future of Horizon has hung in the balance. Work has been
undertaken urgently on the contingency that Horizon would be aborted. The
pace and confidentiality of negotiations has prevented full communication.
During my team’s extensive interview programme with key managers they
became asvare that few people seemed to have the complete picture.
A significant result of this is that Horizon has become separated from the
strategy development programme, either because strategists have come to
doubt whether it would proceed (or at least soon enough to be useful), or
because they regard it as an unsuitable delivery vehicle for their strategies. It
does not yet seem to be widely appreciated that if Horizon proceeds now,
it will be the principal, and probably the only way POCL will have to
deliver strategic change for the foreseeable future, and every other project
will have to be managed in the light of it. It is still unclear how far the
partnership with ICL will have to impinge on other activities. It is also
becoming evident that budgetary pressures will reinforce the need for single
focus on Horizon.
in summary, there are drawbacks and uncertainties with going ahead, but they
are not greater than those associated with termination. Going ahead will
require very heavy, single minded commitment to Horizon and to the
partnership with ICL in order to minimise the drawbacks.
Recommendations: Issues to address
The high profile of the Horizon renegotiation, and ‘The Post Office’s support
of Horizon against significant opposition mean that failure to make the deal
stick with a successful implementation would be politically and commercially
extremely damaging. It is of great importance for the credibility of The
Post Office (not just POCL) that it should be seen to have judged the
debate correctly and made the right decision.
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Furthermore, POCL*s commercial success will now depend heavily on
Horizon. It will not have the funds for altematives. Horizon must therefore be
implemented in a way which ensures achievement of service and commercial
goals, for customers and clients. To be sure of this, the approach to
developing the business vision will need to be adapted to become visib’
Horizon-centric. People’s enthusiasm for finding work-arounds and
alternative approaches will need to be firmly channelled into making Horizon
deliver what is required. 1t is likely that this Horizon-centricity will need 10
apply beyond the bounds of the current POCL business. Shaping for
Competitive Success will need to ensure that organisation boundaries
facilitate effective operation of Horizon and the ICL partnership, and not
make it gratuitously more difficult.
e the centrality of
the network and to
Communication of new vision also needs to acknowled,
Horizon. Failure to do so will give very strange signals t
fCL.
3
34
The working relationship with ICL needs to change so that they do not hide
behind the PFI to avoid sharing full understanding of the system's capability
and construction, The effect of failure would be profound for both parties, so
there is evident common ground for a worthwhile partnership, But trust must
be re-established, and an environment created in which success is the sole
motivator.
This is particularly important for the Horizon testing regime. Both ICL and
POCL need to be committed to implementing releases that demonstrably
work, since the potential for disruption and loss of credibility is enormous if
the system is error prone, given the pace of planned roll out.
Itis desirable to ensure that POCL’s and ICL’s understanding and
interpretation of risk are congruent. Nothing less than the reputation of POCL
is at stake, on which the projected business volumes are partly dependent. It is
important that both parties recognise the high standards of accuracy required
for the conduct of transactions on behalf of third parties.
3.7 AS ICL Pathway has a large funding requirement there might be advantage in
conducting due diligence of its financial strength and that of its parent ICL, if
this has not already been done.
38 Asignificant “bridge-building” exercise with BA is indicated.
3.9 The Management Process of POCL needs to be reviewed to examine whether
it will support primacy to Horizon, or whether it encourages the development
of competing activities which make implementation more difficult, and which
the business may not anyway be able to afford. Major Post Office wide
projects should also be included in the review.
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3,10 The partnership proposition has not been subject to as extensive review as the
financial deal, and now needs to receive it.
3.1 Clear signals need to be given to managers that implementing Horizon,
and working in partnership with ICL to exploit it for commercial
advantage, make up the “most important game in town”. The CEC will
need to back the 4. ull commitment, and not
underestimate the need it brings for very sharp focus.
Roger Tabor, Finance Director POCL January 1999
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Appendix A
The Strategic issue
* The historic role of post offices is being undermined by a combination of
technological obsolescence, disintermediation, “unbundled” competition, and cost
ssures on public service clients. Nevertheless customers like post offices and
repositioned ways of exploiting them profitably were identified in Counters New
Vision.
* Ithas always been a focus ters strategy that the continued existence of a
network of post offices (even if differently configured and smaller than the present)
is both politically and commercially desirable, but needs to be actively secured by
a sufficient volume of business. Issues about the network are at Annex [ to this
appendix,
* All potential future developments in the vision for post offices require automation
of the network. Horizon is the only automation currently available. Although
alternatives are both conceivable and practicable, and might be more immediately
suitable, they require extensive investment, and would probably take about two
years longer.
* Since repositioning the post office network requires automation first, it is critical to
the future of the business to buy time to implement automation, by prolonging the
viability of the current, threatened mix of business as long as possible. Payment of
benefits is the most important part of this, because it accounts for more than a third
of counter network revenues, and its footfall boosts other transactions.
* The Horizon related deal includes agreement by BA not to withdraw benefit
payments from post offices until the end of the contract period. (Actually, to pay
POCL never less than a real 3% fall, year on year.) Without Horizon this
guarantee is not likely to be sustainable.
* Withdrawal of benefit payments from post offices is expected to be by compulsory
automated credit transfer (ACT) to bank accounts. POCL might retain a significant
share of payments if it had the operating capability to debit and credit the accounts
of customers of the major banks. The Network Bank strategy to capitalise on the
closure of bank branches envisages such capability, but not necessarily for all
banks within the timescale for ACT.
* Horizon does not currently offer universal banking functionality but it is expected
that it can be made to, The urgency to do this quickly to prepare for ACT is
moderated by the longer pre-ACT period if Horizon proceeds, but similar
functionality is required for the Network Bank strategy anyway.
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* Without Horizon it would be necessary to develop and implement an alternative
automation approach, against the background of a likely more rapid move to ACT
by BA, and a possible general question mark over the feasibility of automating post
offices after the second failure ina deeade. Although lessons from Horizon, and
the benefit of a much better understanding now of key requirements, would
increase the chances of success, this would remain a tough proposition.
¢ The implication of this analysis is that Horizon proceeding does buy time to
prepare for ACT and to lay groundwork for the new vision. Unfortunately, though,
even then, the strategy cannot be guaranteed, because the combination of the high
cost of implementing and operating Horizon with the deteriorating business income
prospects for 1999-2000 means that it will not be feasible to fund any major
strategic development beyond automation.
e The budgetary crisis has one important beneficial spin-off: it will force absolute
focus on Horizon implementation, which is in any case critical for its success.
Work on other aspects of strategy and vision will not be affordable unless it is fully
consistent with that focus,
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Annex I to Appendix A
Network
* Business Plan assumption is that we continue to lose about 206 offices per year.
um size of the network, There are
» accessibility and capacity.
¢ Work has been carried out on assessing the opti
3 main drivers of the size of the network-efficienc
« Basing accessibility on 90% of the population being within I mile of the Post
Office and 99% within 3 miles, the optimum size of the network is probably some
12,000 to 13,000 offices.
e Those offices to be closed would be medium sized offices whereas our current
losses are mostly small rural offices.
« To achieve this level of reduction would take about 10 years and cost in excess of
£150m in one off compensation payments. The agreed terms for compensation for
loss of offices means that it is virtually impossible to save money in the year of
closing a sub office.
* Based on current turnover trends and the saleability of offices it is safe to assume
that at current levels of business, the sub office network is a viable proposition for
agents. But trade in offices is distorted by the existence of mandatory
comperisation for non-renewal of the office on resignation.
* With static or threatened business volume it is increasingly difficult for POCL to
afford the operating costs of a 19,000 office network, Network viability depends
on assumptions about business retention on closure, but there is some evidence to
support the view that a networ Il large enough to be called “universal” can be
viable. (See 3" bullet above)
¢ The cessation of Horizon and any subsequent move to ACT would impact on the
income of sub offices. BA accounts for a third of POCL volume and income and
therefore is a significant part of subposimasters’ pay. There is also an impact on the
private business, calculated at between 10-1
* Installing Horizon adds to the cost base of every office, thus increasing the
strategic cost pressure to have a (controlled) smaller network. But for reducing the
network size to contribute towards a reduced Horizon implementation
closures would need to pre automation roll cut: if network downsi:
year programme most closures will affect already autornated offices.
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Appendix B
The Financial Context
Annex I
Annex 2
Annex 3
Annex 4
Summary of key assumptions
The base case before deciding to automate
The business case for the contract as awarded
Termination option - key assumptions (Treasury)
The deal
Overall NPV, summary
- comparison with negotiating authority
Sensitivity of NPV
to further delay to Horizon
- to the timing/extent of loss of BA benefit under
termination
Key risks
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Annex I to Appendix B
Summary of Assumptions
Assumptions INo-Automation Original Termination Current
L Baseline Business Case Proposal
Period Covered [April 1996 to April 1996 to 1986 to April 1996 to
by Cash Flows [February 2005 February 2008 arch 2010 March 2010
DSS Contract
End date
naual contracts [February 2005 March 2008 March 2608
Structure Fixed + Variable
Current Fixed+ ICurrent Fixed +
Variable structure Variable structure
retained retained larch
2007, with £10m
p.a. reduction in
i fixed payment from
April 2005
Total payment of
£1 15m in 2007/8
vetained
Cirecheque No payment from Addition to fixed [No payment from [Addition to fixed
migration DSS - paid by payment when DSS - paid by payment when.
Girobank girocheques Girebank sgirocheques
migrated to card migrated to card
Guarantee No guarantee S% year-on-year 3% year-on-year 3% year-on-year
floor until March floor until! March floor until March
2002 2007
Efficiency RPL-X% [Xo1] RPI 1% RPI-1% RPL 1%
ACT Migration
Sta
April 2005, IStarts April 2001, [Starte April 2005,
in costing ars takes 3 years, takes 3 years,
period, but dyi [2O%O07 140% 20°4/4026/40%
accelerated. i
Other (existing) [Business centre Business centre Current business x siness
non-benefits forecasts adjusted [forecasts from plan forecasts centre forecasts
business following audit by (1996/7 planning reduced for lower
f round footfall resulting
from loss of BA
pcustomers
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Vision} business
Assumptions INo-Automation (Original ‘Termination Current
Baseline Business Case (Proposa’ I
ew Banking [net included nat included Project Amber I
iness Intertn Banking
Fall alternative amount quoted by
solution from 2003 [Pathway dower
han both POCL
I figures}
Other new (New [not included mot included mot included mot included
‘Operational
don PCCM — [Based on PCOM
Based on ABC
Based on ABC
Pathway
Contract
nf Ends February
2005
nla
Ends March 2010
System costs
Extrapolation of
ECCO and APT
already equipped
with them
Project Amber
‘costs plus
estimated costes for
acquiring new
POCL-owned
systems at all
outlets:
Negotiated
from ICL Pathway
POCL Project
costs
not applicable Ag estimated in
outline business
case
High level
estimates based on
overall resource
levels expected to
be required for new I
project
Current Horizon
and Service
management
usinese plan
stimates based on
work area costings
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NPV Summary Annex 2 to Appendix B
ALL FIGURES IN £M NPY BASIC (CUSTOMERIRISKS [TOTAL
VALUE
BASELINE 153.0 te) “104 $2.0)
FULLY TERMINATE (49.1) 39 -289} (279.1})
LATEST DEAL 314.7) 146) “152 308.7)
Annual Profit Summary
1999/0 2000/1 2001/2 = 2002/3 2003/4 = 2004/5 = 2005/8 = 2008/7 2007/8 = 2008/9 2009/10 2010/17 I
BUSINESS PLAN Note 7 30.0 60 (8.8) (2.0) 36.0 36.0 36.0 36.9 36.0 36.5 36.5 36.0) I
BASELINE 29.0 16.0 09 7.2 47.3 16.5 (22.9) (425.8) (242.0) (274.0) (284.41) (28.5)
FULLY TERMINATE 86.3 (B77) 25.3 (64.6) (12.0) (63.2) (245.9) (248.3) (247.4) (248.5) (249.6) (238.4)
LATEST DEAL — Note 2 34.2 3.8 O73) (16.6) 49.4 (8.1) 9) 63.8 (35.7) (102.7) (77.8) (49.8)
Note 1 includes - “new vision"
Note 2 Does not include new vision
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NPY £m
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Sensitivities of NPV Annex 3 to Appendix B
~~ Sensitivity of Fully Terminate Option to delays in migration
~~ Sensitivity of Latest Deal to delays in rollout
400
350
300
230
200
150
30
0 an a -
No Delay 1 Year Delay 2 Year Delay 3 Year Delay
Delays to ACT/ Rollout
The delays to the new deal rollout do not include any assumptions about the
likelihood of clients looking for other means of transacting business, because of
Counters failure to deliver an automated solution
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Annex 4 te Appendix B
Risks - Negotiated Continuation
LENPV Em)
VAT on Benefit Encashment Service and Order Book Control Services
Customs and Excise have ruled that the services POCL provides to BA under
Contract B (transmission services) are exempt from VAT, even though this contract
i k-to-back with the services Pathway provides to POCL. The consequence of
that either POCL charges the full amount to BA, who are then unable to
from the Treasury, or that POCL charges the amount less VAT, in
takes a loss. POCL’s view is that the former would apply, BA
that it would be the latter,
Eom
BES/PAS/CMS Price increase
BA are positioning themselves as having “given” as much as they can in the
Corbett proposal. The Pathway proposal includes price increases on BES, CMS &
PAS which will all be contracted for with POCL. Given BA’s current positioning
there is a risk that POCL will not be able to recover these extra costs from BA,
+£8m
RPI on Pathway Price
With the exception of the Pathway Proposal, all cases assume that Pathway would
absorb RPI increases upto 6%pa. Should RP! be above this amount then Pathway
charges would increase by 50% of the amount over 6%.
The Pathway Proposal incorporates a pricing formula which allows for Pathway
charges to be adjusted by RPI less 2%efficiency. This risk has been evaluated by
assuming that actual RPI is 4.0% per annum as opposed to the working assumption
of 2.5%
fim
Failure to achieve roll-out beat rate
The contract provides for a roll-out rate of 300 post offices per week. Any shortfall
below this could be the basis for a claim from Pathway for compensation for loss of
income. POCL is developing plans to meet the 300 per week rate, but resourcing
levels for these are critical, and the practicality of achieving this rate needs to be
proven in practice - especially since independent reviews of the programme have
highlighted this as a particular risk area.
The Pathway Proposal roll-out guarantees are fixed and therefore a significant
reduction in beat rate could trigger guarantee payments.
‘The risk is evaluated on the basis of a 20% shortfall - Le. 240 per week achieved
rate.
POCL Implementation casts (staffing etc.) increased.
This is linked to the beat-rate risk above. If resources planned to support the rofl-
out prove inadequate, then POCL would need to provide additional field support
staff and/or buy additional services (mainly longer training courses) from
Pathway. Higher costs are already built into the replacement programme for the
Termination option,
-£om
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Risks - Negotiated Continuation
ENPV in}
Delay in achieving banking capability,
Options assume a timescale for availability of network banking capability on I
Horiz the replacement system. This is & ‘hieving the assumed level I
of retention of ex-henelits customers following introduction of compulsory ACT.
telay to this capability (or to the commercial agreements with banks to exploit
would therefore worsen the case.
»sal has identified separate fixed guarantees for banking
herefore, under this proposal delays to the implementation of
on the system could have additional casts to POCL.
uated for a 12 months delay in each case. i
18 month notice of termination
Pathway Proposal includes an 18 month rolling notice period. This may
in POCL paying higher prices for longer than would otherwise have been
The risk has been evaluated by assuming that market prices are 50% of Pathway
prices for the last 18 months of the proposed POCL/ Pathway contract.
result
Se,
Elim
Automation Savings not achieved
The model inchides savings as a result of replacing POCLs existing automation
with timing varying according to the nature of the scenarios There is a risk that
delays in achieving the new automation will result in loss of these savings as
systems have to be supported for longer than planned.
Other new business income attributable to Horizon not achieved
The model includes contributions from non-benefits business that is automation
dependant - mainly growth in automated payments and re-engineering of existing
products (Le, tactical, not longer term developments towards POCL’s new
strategy). There is a risk that delays in achieving the automation will put these
benefits at risk as clients seek alternative channels.
Higher prices in the Corbett, and especially the Pathway proposals in later years
could lead to POCL being less competitive in key markets and lower market share.
Contribution from Banking lower than anticipated
he mode! includes income from banking on the assumption that banks would pay
POCL £25 per account per annum for providing branch banking capabilities to ex-
benefits customers (probably in jointly-branded accounts). This is consistent with
the analysis of the branch banking market that McKinsey’s undertook for POCL as
part of the strategy review, but achieving this will depend on POCL’s success in
negotiating a share of the bank’s savings. Delays and/or cancellation of Horizon
would weaken POCL’s position in such negotiations, as would any earlier move to
ACT
been evaluated on the basis of POCL only receiving £15 per account
income.
430m
Balance Sheet Impact
We have been advised by our external auditors that, in accordance with FRSS,
POCL may now need to recognise the programme on its balance sheet depending
on the amount of risk/ reward of ownership of project assets.
Due to the higher guarantees demanded in Pathway Proposal the “demand risk” is
virtually transferred to POCL and therefore there is a greater probability that we
will need ta recognise the programme on the balance sheet.
Recogr on the balance sheet could lead to serious Profit and Loss impacts
Not
Evaluated
which have not yet been evaluated,
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Risks - Negotiated Continuation
NPV Er}
Changes in law
The Pathway Proposal states that where a discriminatory changes in law occurs,
POCL should indemnify Pathway’s costs involved in implementing any resulting
change that is required. The Pathway Proposal also states that Pathway’s exposure
to general change in law should be subject to a risk sharing mechanisin
Evaluated
Not
Risks - Termination
v
£m)
Delay in achieving banking capability.
Options assume a timescale for availability of network banking capability on
Horizon or the replacement system. This is essential to achieving the assumed leve'
of retention of ex-benefits customers following introduction of compulsory ACT.
Any delay to this capabi ‘© the commercial agreements with banks to exploit
it) would therefore worse case.
‘The Pathway Proposal has identified separate fixed guarantees for banking
transactions, refore, under this proposal delays to the implementation of
banking on the system could have additional costs t POCL.
Risk evaluated for a 12 months delay in each case.
“E102m
Cost of replacement solution if Horizon terminated
Only broad-brush estimates are available for the cost of procuring a replacement
for Horizon if contracts are terminated. Mid-line estimates have been used. The
risk represents an addition to high-line cost estimates.
-f6om
Other new business income attributable to Horizon not achieved
The model includes contributions from non-benefits business that is automation
dependant - mainly growth in automated payments and re-engineering of existing
products (ie. tactical, not longer term developments towards FOCL's new
strategy). There is a risk that delays in achieving the automation will put these
benefits at risk as clients seek alternative channels.
Higher prices in the Corbett, and especially the Pathway proposals in later years
could lead to POCL, being less competitive in key markets and lower market share.
Contribution from Banking lower than anticipated
The model includes income from banking on the assumption that banks would pay
POCL £25 per account per arnium for providing branch banking capabilities to ex-
benefits customers (probably in jointly-branded accounts). This is consistent with
the analysis of the branch banking market that McKinsey’s undertook for POCL as
part of the strategy review, but achieving this will depend on POCL’s success in
negotiating a share of the bank ings. Delays and/or cancellation of Horizon
would weaken POCL’s position in such negotiations, as would any earlier move to
ACT.
The risk has been evaluated on the basis of POCL only receiving £15 per account
per annum income, I
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Appendix C
Benefits Agency
* BA accounts for a third of all POCL volume and income.
* BA strategy has 2 main drivers: cost and fraud prevention
* Contract A applies until 2008. From 2005 compulsory ACT on the basi
* There was a serious threat of compulsory ACT in 92/93. This was dropped following a
campaign by subpostmasters and POCL.
These findin:
* A review was undertaken at that time to evaluate the impac
The key findings were:
ere updated in
loss of 60% of BA transactions at steady state. a loss of 16% total business.
Loss of 6% of other POCL business through reduced footfall.
Subpostmasters private business would be impacted by between 10-15%.
Destabilisation of the network with about 4.300 offices being forced to close.
Closure of 300 Crown offices.
Unless subsidies considered, the Government would be responsible for the
reduction of customer choice and the loss of about 17,000 jobs.
The UK coin flows would be seriously affected.
There would still be a need for a fraud prevention scheme for those benefits stil!
paid using foils.
There would be an adverse impact on Girobank business.
¢ Relationships with BA are difficult at some levels of contact. BA are reluctant partners in
n and interviewees felt that BA were exploring other ways of paying benefit without
informing POCL e.g. the NatWest ATM. benefit payment trial.
* The threat of compulsory ACT to the timescales being discussed in the current negotiations
appear to be unrealistic (starting in 2001 is one date being discussed in the negotiations.)
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« Given the adverse social implications rehearsed above, there must be a real doubt as to
whether a rapid move to compulsory ACT is really an option for the Government. But BA
could change the periodicity of payments to fortnightly (from weekly at counters and monthly
by ACT) thus improving the relative attractiveness of ACT
option of re ig only OBCS (option 2) is now being put forward by BA in this current
round of negotiations. This does not give anything like the fraud prevention levels of the Card
em (as illustrated by the recent Operation Scorpio exercise). It has been surmised that one
n why BA would be keen on this option would be if they were concerned that their own
system, under development (CAPs) was at risk of not delivering to specification. [ have not
seen or sought evidence of that, though were that to be the case it woul: pose a risk to
Horizon as the systems have interdependencies.
Conclusions and recommendations
The failure of Horizon threatens compulsory ACT to earlier timescales. It also negates contract
Aand probably reduces POCL income (price floor protection from volume loss clause would
fall}. It is important to consider carefully how realistic the threat of earlier compulsory ACT is
and indeed, whether compulsory ACT is really a strategy the Government would want to pursue.
‘The business has accepted that ACT is unstoppable whether by compulsion or migration aided
by incentives, We know that the benefits to the Government are not as great as first thought since
costs were understated and there is still the propessity for fraud, It may also be significant that
BA are pushing OBCS as the solution in the current round of negotiations.
It is recoramended that we should set up a Partnership, outside of the negotiation channel, to
work with BA on how ACT is rolled out to the benefit of both parties, We should share our
business plan, in particular Network Banking, and see how this could be developed to mutual
advantage. Clearly, for this to happen both sides have to be committed and we have to take a
much more challenging /analytical stance to BAs strategy, as well as our own, if we are to
develop a strategic partnership. This recommendation is critical to the success of the project.
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Appendix D
ICL Pathway
* The contract between Counters and POCL is for ICL Pathway to deliver an automated Post
Office network infrastructure. The network to be con
* Roll out should have started in June "97 with a completion date of 1999,
Sncashment Service for Child
due to be
» Currently there are 204 sites which are trialling the Benefit
rolled out in August °99 . Thereafter timescales are subject to validation.
« The POCL contract negotiating team and those close to the development of the system have
expressed reservations about the professionalism and the quality of some of ICL Pathways
work.
y have used the fact that the contract is a PFI te avoid
exposing the existence of problems. For example, requests for documentation of systems
have been refused on the grounds that the PFI relationship is to provide a service, not a
system, swith the implication that POCL should not be concerned with the detail how. The
Horizon team have resorted to documenting what they think the technical design is and
passing it to [CL for confirmation.
* There is a suspicion that ICL Pathy
e Testing to date has revealed some design flaws which are being resolved. There is currently
no absolute assurance that Horizen will fully deliver all POCL."s required outputs e.g. client
settlement. agents remuneration etc. All these issues have to be resolved, but recent
collaboration has been more encouraging.
* Fujitsu have given their backing to [CL Pathway for the project, and accepted a need to
provide a guarantee. Draft Heads of Agreement prepared by Slaughters and May include the
terms of this, but have yet to be agreed with ICL.
The network commitment and enthusiasm to make Horizon work are impres
ownside, the roll out rate of 300 is thought to be too untried and high risk. There are
urrently no contingency plans in place if errors become unmanageable.
* All those interviewed felt there would be further slippage in timescales and expressed
concern that ICL would continue to come back and renegotiate at regular intervals.
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ent timescales. The contract allows for evo
means. Th t deal with ICL excludes
vill have to be explored fur Si
es of new initiatives
serious concerns about the devele
ure what th
e There are
new releases a year but no one
@ guarantees on new busine:
chow we could explore together tt
final negotiation included the signing of Heads of Agreement as
with ICL. Although this document is “not intended to be legally binding
expected by the parties that it will be the basis for the relationship between ICL and POCL.
Sinee, under SCS, POCL will not exist in its current form, one may assume that ICL expect
that this agreement will be honoured by the Post Office. It is not evident that any Post Office
ity and their ability to deliver an automated network to the timescales now being
ving said this, ICL see POCL as not being totally committed, being unsure what
‘ategy really is and not providing high quality resource to the project.
I: is recommended that the outcome of the latest negotiations is used to reposition the PFI
since they fundamentally change ICL’s relationship with Counters, which now
re transparency between the two parties. In addition, there need to be joint
discussions with ICL Pathway to establish how to ensure live trial of release 2 goes ahead to
timescale and that it is successful, providing a stable platform for the remainder of the
development releases.
The impact of the Partnership agreement on wider POCL and Post Office strategy need to be
urgently reviewed.
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Appendix E
Vision and future Business Strategy
* Work has been ongoing to secure the future of POCL. This work has been facilitated by
MeKinseys.
* From this work, a number of strands were identified as being worth further scoping and
programme boards have been set up to manage this work. This has taken considerable
resource including some of our most able senior managers, who are therefore not available to
work on Horizon implementation.
« Atthe same time the Post Office has been undertaking a review of its structure. The outcome
of this work will be a total reorganisation of the business away from the 4 businesses we
currently have. This new structure is due to be in place within the next 18 months.
e The two elements of Counters vision which significantly affect or are affected by Horizon are
Network Banking and Government Gateway. These are areas in which ICL will expect to be
POCL’s principal partner.
* Network Banking envisions POCL carrying out cash inpayments and outpayments on behalf
of one or more banks. This ties in with the banks strategy of closing branches. In order to
provide this service POCL has to have an automated network which includes on line
authorisation facilities and can interface with the banks own computer system. Horizon ha
distributed technical architecture and although external advice indicates it can be made to
accept front end banking, it will be expensive,
* Yo combat the threat of ACT, Counters has been developing an approach to Universal
Banking which would enable benefit payments through the Counter.
» The two initiatives above need to be scoped in order to secure the long term future of
Counters but it is important that throughout their further scoping there is a reality check
against the business chosen counter automation strategy.
* Government Gateway requires an automated network to offer an infrastructure which would
meet the Governments requirements. This suggests we need to deliver Horizon. However.
during the preparation of this report, it was brought to our attention that the PO restructuring
team were envisaging some aspects of Government Gateway through their Customer
Management strand.
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Conclusions and recommendations
Horizon does not appear to be unequivocally at the forefront of POCL strategy. The delay in the
programme roll out owed the development of ew vision but has also provided the
opportunity to di resource and focus. In addition, however far away Horizon is from what we
would do if we were taking the automation decision now, we have to return it to the foref of
our thinking and work with it. [tis recommended that we re} jon Horizon within the business
and, that in so doing, we ensure the Shaping for Competitive Success is also aware of Counters
strategy.
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List of Interviewees
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Appendix F
Specialist area
Dave Morphey
I ves . .
_ Counters Vision, Project X and preparation
Mike Granville
Andy Radka
_ Network Strategy
Services Management
“David Smith
Automation Strategy
Linda Hanratty
Benefits Agency and Commercial Strategy
Tom Simmonds
Benefits Agency
f
i
_ Jim Green
Network Banking
I Dave Waltho
Government Gateway and Commercial Strategy
Wendy Powney
IS Strategy, Project X and Network Bank
Negotiating Authority
Mena Rego
Kevin Corrigan
Negotiating Authority
_ Keith Baines
I Negotiating Authority
Liz Blackburn
Negotiating Authority
Tim Brown
Finance and Negotiating Authority
_ Ruth Holleran
Horizon Project
Nick Beale
Horizon Project
I Anthea Bourne
Business Plarming (Project X)
In addition Paul Rich, Jonathan Evans and Dave Miller have been consulted in correspondence.
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Brainstorm of Issues to be Addressed
Questions to answer
Arguments to test
Reasons for continuing
View of not automating?
How long without major
risks before w
main PO objectives are
Is Horizon better than not
Horizon and for how long?
Impact on: Costs
Risks
Strategy
Opportunity for
benefits
What does automating but
not with Horizon look like?
ts Horizon affordable?
Is the network more
sustainable with Horizon?
«
°
Automation is critical for
credibility with new and
existing clients.
Necessary to retain BA
business and enable fraud
The need to automate all
offices.
Horizon is the only/best
way to get this within an
acceptable time frame.
It is better to do Horizon
otherwise:
we'd lose BA to ACT
faster.
an alternative couldn't
be done soon/cheaply
enough,
the network couldn't
be sustained (without
subsidy.)
inefficient time to
deliver the new vision,
Best available course.
Losing benefits to ACT is a
real threat.
No realistic alternative
Marginal difference to not
proceeding but more
confidence in the outcome
or significant disadvantages
which could not be factored
into the numerical analysis.
Certainty that there was no
significant exposure to risk
and this could be
controlled by Counters.
It will be delivered.
A strategy in place if the
same problems emerged
later.
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f
ii
I Do we get locked into
bailing ICL. out time and
again?
* ts the downturn in our
income material to the
issue?
_# Are there any more pitfalls
to come?
* Can we afford it within
Profit and EFL.
constraints/targets?
« The deal with ICL satisfies
our concerns about:
the SUITABILITY of
the automation
solution
ability to deliver
on time and meets
quality standards.
risk of [CL running out I
of money again.
their value as our
locked-in “vi
partner”.
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