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POST. JARD
AN UPDATE ON THE HORIZON PROGRAMME
1 PURPOSE
1.1. The purpose of this paper is to:
* compare the financial impact of the new position on Horizon to the
original business case proposal of April 1996 and to Post Office Counters
Ltd’s Business Plan for 1999/2000 to 2003/2004;
* provide an update on programme progress, emerging issues and the
plans for future commercial enhancements,
2. FINANCIAL IMPACTS
2.1 Comparison of new business case to original proposal
21.1 The original business case, presented in April 1996, showed a posifive NPV
of £65m, The revised business case presented to the Investment Board in October
1999 shows a negative NPV of £181m, The movements resulting in the £246m
worsening in the NPV are summarised in Annex A.
21.2 The major reasons for the decline in project NPV are:
«The original contract was arranged under HM Government's Private Finance
Initiative, with ICL Pathway providing the up-front investment and Post Office
Counters Ltd and the Benefits Agency paying on a per transaction basis once
the system was delivered. The charging structure under the new contract is
largely fixed with Post Office Counters Ltd alone making large up-front capital
payments for system and an ongoing operating charge once it is in place; this
significantly increases overall costs.
« Repeated programme delays, cancellation of the Benefit Payment Card and the
proposed migration to Automated Credit Transfer (ACT), have led to a
decrease in the incremental income anticipated as a result of implementing the
Horizon system.
21.3 The business cases are not directly comparable in terms of assessing
business impact as they rely on different baselines and costing methodologies.
These differences are explained in more detail in Annex B.
21.4 The October 1999 cash flow, reviewed by the Investment Board included
£480m funding from The Post Office reserves, in accordance with the Secretary of
State for Trade and Industry's letter to The Post Office Chairman, dated 234 May
1999, This letter stated that this amount would otherwise pass to Government on.
restructuring of The Post Office balance sheet in 2002/03. This will not now take
place. Any Post Office Counters Ltd shortfall will be covered by Post Office Group
funds. This will not have any cash flow impact.
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2.2. Revised business plan impacts
2.2.1 An initial assessment of the business impact of the Codified Agreement
signed in May 1999 was presented to the Post Office Board in July 1999 (PO99/78)
and of the five scenarios considered at that time, it was agreed that Scenario 2,
Horizon continues with heavy proniotion of ACT from 2001, would be taken forward.
22.2 The scenario has been revised to reflect the new business case and the
requirement to account for Horizon Contract as an impaired asset in the current year
(but does not include the impact of the current planning round). The impact of these
changes on Post Office Counters Ltd’s projected profit is shown in Table 1. The
changes shown reflect the new contract, plans for migration of benefits business to
ACT, and the associated impacts on Government Gateway and Network Banking
initiatives. The major reasons for changes to profit are highlighted in Annex C.
Table 1: Impact of revised position on projected profit for Post Office Counters Lid
ém at outturn 1999/0012000/01 [2001 /02/2002/03/2003/04ITOTAL I
Post Office Counters Ltd 30 32 50} 70 77) 261)
Business Plan 1999/00
Revised Position - New 62, 49) 6 2) -(699)
Business Case and Impairment
Change G53} BHT 03) 4] (159/960)
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3. ISSUES AND RISKS
31. Review of post-acceptance period
3.1.1 Under the terms of the Codified Agreement, signed on 28% July 1999,
Contractual Acceptance was scheduled to happen in August. However, acceptance
testing identified significant faults in ICL Pathway’s service and Acceptance was
deferred under the First Supplemental Agreement.
3.1.2 By 24%September 1999, most of the faults had been corrected, but ICL
Pathway were still adjudged to be failing on the following three criteria:
* Helpdesks - provision of support to offices failed to meet contracted service levels;
* System Stability - software errors were observed during live trial which could
have significant customer service implications when the system is fully rolled out;
« Accounting Integrity - the lack of demonstrable controls within ICL Pathway
were leading to an unacceptably high level of data with integrity problems.
3.1.3 After reviewing risks it was decided that despite these recurring problems
there were significant business benefits to be gained from rollout to a larger
number of offices, but that this should be subject to additional obligations on ICL
Pathway. These obligations form the Second Supplemental Agreement whose
provisions include:
« Targeted reduction in faults and additiona! functionality to put integrity
controls in place;
«The time and cost adjustments which would have been due to ICL Pathway if
Post Office Counters Ltd delayed rollout are now disregarded for a period of 42
days - this significantly mitigates rollout risk;
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¢ Post Office Counters Ltd retaining the option to suspend resumption of rollout
in January 2000, if the criteria at 3.1.2 are not met.
3.1.4 The Horizon System has been successfully rolled out to 1,857 offices prior
to the suspension of rollout for the Christmas period. ‘The current assessment is
that ICL Pathway have achieved acceptable performance levels on the system
stability issue, but that further monitoring and discussion is required on helpdesk
and accounting integrity issues. As a result, a final decision on resumption of
rollout will be taken in mid-January 2000.
3.2. Overview of relationship with ICL Pathway
2.1 The codified agreement is a shift from the previous tripartite agreement
(involving the Department of Social Security), to a bipartite arrangement. This has
simplified the contractual relationship and led to a better definition of processes for
dispute resolution.
3.2.2. The basis of payments included in the Codified Agreement are primarily
fixed payments for specified deliverables. As a result, the behaviour of ICL
Pathway appears to be a cost minimisation strategy in meeting their contractual
requirements. This has meant that Post Office Network Unit management has had
to take a firm negotiating line, and has resulted in contractual discussions being
escalated to senior levels before the contractor delivered acceptable performance.
3.3. Release plans for future commercial enhancements
3.3.1 The functionality that ICL Pathway has contracted to provide at the
specified price in the Codified Agreement is limited to:
... the Core Release providing:
basic till and outlet accounting functionality;
« bar-coded and magnetic-stripe bill payment;
« the order book control service for benefit payment.
_.. and Core Release Plus (available in Autumn 2000), providing:
* smart card bill payment;
e a front-end for stock and cash management systems;
* infrastructure developments to improve security for automated
payments and allow the provision of data direct to clients.
3.3.2. Subsequent to the Core Releases the earliest opportunity for significant
software development and testing, will be Spring 2001. Prior to this, there is also
the opportunity to re-engineer additional clients and products to use the bar-code,
magnetic-stripe and smart card payment functionality already available.
33.3 Within the Codified Agreement, Post Office Counters Ltd’s commitment to
n Horizon is limited to an obligation to discuss potential
with ICL Pathway. ICL have been included in the
Request for Information sent to potential suppliers of the Network Banking
Initiative, and a dialogue has been initiated by Post Office Network Unit with ICL
Pathway on potential developments in this area and in Modern Government.
further development o:
partnership opportunities
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RECOMMENDATION
The Board is invited to:
NOTE that:
(i) sunk costs on the programme to end of August 1999 amount to £47.8m;
(ii) further forecast expenditure in relation to programme management and
implementation costs of £42.0m was authorised by the Investment
Board in October 1999;
(iii) the committed contractual payment to ICL Pathway of £564m was
authorised by The Post Office Board in July 1999;
(iv) the following recurring costs of Horizon are forecast from the start of
1999/00;
£m at 1999/00 I2000/01 12001 /02 I2002/03 I2003/04 I2004/05 ITOTAL I
outturn
Payments to (10) (80), G13) (18) 21a) G59)
Pathway
Other costs (1) (2) (2) (2)) (2) (1) (9)
Total (10)! (82), a5)] I) (422)I—A79)] (G08)
(v) the following key project milestones have been set:
« Planned resumption of national rollout 24 January 2000
¢ Completion of physical rollout of post offices June 2001
« End of current contract term with [CL Pathway March 2005
SS
January 2000
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ANNEX A
Comparison of original case NPV with current proposal
A reconciliation of the overall differences between the original automation case
and the revised business case as authorised by the Investment Board in October
1999 is summarised below,
£m Sub- Net NPV at
totals Change 12% TDR
Original Case - April 1996 65
Adjustments to allow cashflow comparison
Rebase case to 1999/00, 45
Omit "sunk" cost/ benefits to end 1998/99 (18)
27
Impact of BA withdrawal/contract change on system related costs
Pathway Charges- Benefit Encashment 212
Pathway Charges - Operating Payments (21)
Payments from Benefits Agency for automated (10)
benefit payment
Capital Payments to ICL Pathway (492)
Payment for card issue/ Back office savings (91)
(502)
Loss of contribution
Incremental contribution from benefits (113)
business
Incremental contribution from other business 39
(74)
Opportunity Saving
Originally proposed drawdown of £480m from — 342
Post Office reserves* . ee
342
Implementation and recurring costs/benefits
Programme and Implementation costs (NRR) (48)
Other recurring costs 35
Other benefits 3
Savings on legacy automation systems __28) _
(38)
New Business Case - October 1999 (481)
1 The interpretation of the “Opportunity Saving” has been changed since the Investment
Board, see Paragraph 2.1.4 in the main paper for an explanation of this change. ‘This saving is
no longer likely to be a cash flow impact, the revised NPV without the saving would be
negative £523m.
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ANNEX B
Differences in business case assumptions
Both the original and revised cases include estimated benefits in terms of
contribution from clients. This is calculated by comparing estimates of
contribution with Horizon against a base case of no automation. The original base
case was prepared in April 1996 and reflected Post Office Counters Ltd’s
expectations as to likely income if automation was not extended beyond the
systems in place at that time. The October 1999 case was prepared in the light of
the Government's stated intention to migrate benefits customers to a bank account
based benefits solution.
Figure Bi below, illustrates that both the baseline and incremental income figures
are significantly higher under the original case. The main reasons for the decline
in the baseline and increment are:
« ‘The new case only shows the income derived from functionality available on the
basic system. Benefits from re-engineering (allowing potentially large income
streams from Network Bank and Government Gateway programmes), are
omitted.
« The continued delay to Horizon has impacted client confidence, leading to a
decrease both in current and future income as clients seek alternative channels
and are less ambitious in their plans for engineering their products on to the
Horizon platform.
Figure B1 - Comparison of incremental income for new and original business cases
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}
}
woo I “+= Nov 96 Automation
I ~@ Nov % Base Case
800 a Oct 9 Automation
ie Oct 99 Base Case
Oe ee ee — . a _
3995/97 3997/98 1998/92 1989/00 2000/01 20028 2003/04 004/06
Comparison of the cashflow impacts is also affected by a fundamental change in
the basis of costings. The new case uses the Activity Based Costing methodology
which is more effective at allocating costs to products than that used previously.
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ANNEX C
Reasons for overall movements in Profit and Loss from Post Office Counters Ltd
Business Plan to new proposals.
£m at outturn TOTAL Explanation of change I
1999/00 to
I 2003/04
income
Benefits Distribution (including, (221) [Revised scenarios as per July 99 Board,
payment for automation) increased rate of migration to ACT? and
loss of floor from 2003/4
Network Bank and Government (278) IMigration to ACT impacts footfall which
Gateway affects Network Bank offer i
Other income (111) IMigration to ACT impacts footfall which
affects other business
Total Income (A) (611)
Expenditure
Horizon RR
Core products 48 jLarge up-front capital payments result
in an overall decrease in ongoing, F
charges i
Network Bank and (64) Information from Pathway suggests I
Government Gateway higher cost of delivery than previously
anticipated i
Other Core costs 225 = IReductions arising from volume I
decreases I I
Development
Horizon 5 IReductions in project cost identified
Network Bank and {4) _ IEstimates of development costs for
Government Gateway automation on Horizon
Underlying 54 IOther development costs reduced in
response to footfall loss
Total Expenditure (B) 263
Additional Depreciation
Horizon (571) [Write off of Horizon asset in 1999/00
Other (42) Depreciation related to Network
Bank/ Government Gateway capital
expenditure
Total additional depreciation (C) (613)
Profit (A) + (B) + (C) (960)
2ACT refers to Automated Credit Transfer whereby state benefits are paid directiy into
recipients bank accounts.
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