Electronic memo
To:
ee:
Hard Copy To:
Hard Copy ce:
Date:
From:
Subject:
Dawn Howe/e/POSTOFFICEI
02/04/2001 10:18
Keith K Baines
Horizon post 2005.
Please print and pass to me
To:
co:
Hard Copy To:
Hard Copy ce:
Date:
From:
Subject:
Stuart, Dave,
<t
by Keith K
David W Miller/e/POSTOFFIC!I
Sweetman/e/POSTOFFICE
Baines/e/POSTOFFICEY
3/2001 21:04
David X Smith
Horizon post 2005
z
Have now added the Appendices horizon2005.ZiF
Dave
POL00104333
POL00104333
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
Annex A
CONSIGNIA EXECUTIVE BOARD PAPER NO:
EXECUTIVE SUMMARY
The current contract with ICL for the Horizon system runs through to 2005. The
timescales for procurement and system design, build, test and implementation are
such that a decision on th ure of the re ship with ICL is called for now if PO
Ltd is to re: ally choose between all available options. This paper add. he
way forward in the light of input from an independent review on the financial status
and direction of [CL and its parent Fujitsu, a review of 1S Strategy and
legal/procurement advice.
at atime
i extension
The diversion of significant and scarce resource in the proc enit pro
of unprecedented business change leads to the conclusion that on balan
with renegotiation is the preferred option.
STRATEGIC IMPLICATIONS
The preferred option means that PO Ltd’s capability to deliver major initiatives such
as Banking, GGP and ERA will not be diluted by a lengthy and resource hungry
procurement and system replacement project. The option “protects” busin
Additionally negotiation objectives include the funding of sign’
ERA c£65M by ICL and a smoothing of existing costs to create headroom which will
support other strategic programmes.
COSTS/BENEFITS
Negotiation will be supported by a “business as usual teany”. Additional legal fees
will be incurred.
SPONSOR AUTHOR
Stuart Sweetman David Smith
Annex B
1 o2/os/or
[IN STRICTEST CONFIDENCE
POST OFFICE EXECUTIVE BOARD
HORIZON BEYOND 2005
1. Introduction
Horizon contract ends in 2005, Tine needs to procure and replace Horizon I
means we need a business decision now I
The Horizon system, provided under contract as a managed service by ICL Pathway,
is a major component of Post Office Limited’s operating process and so a large
element of its fixed costs, The current contract runs to the end of March 2005. Further
significant developments are planned which will barely be compl
timescale let alone cost in. This paper analyses options for obtaining s
after the current contract and recommends a way forward that takes account of the
wider business context.
In carrying out this analysis three other recent studies have been take into account.
These are:
a) Review of the IS strategy for post offices by Group IS
b) An analysis of the legal/regulatory position carried out by Post Office
Procurement;
c) A review of the financial and commercial status and direction of ICL and
Fujitsu carried out by KPMG,
The background to the current contract is attached as Appendix A.
2. New Developments
There are a number of business critical new developments required on the I
Horizon platform
Extensive changes will be required to the Horizon service over the remainder of the
current contract and subsequently in order to support PO Ltd and Government
strategies for restoring network profitability. Key elements of this are as follows:
* Costs for the development of Network and Universal Banking are likely to fall
within the range £30-50m.
*® Costs for GGP are likely to be of the order of £10m excluding kiosks (if these are
procured from ICL)
» ERA will require a major redevelopment of Horizon functionality. Initial estimates
suggest costs in the order of £60m
Thus development costs over the period are likely to amount to in excess of £100m.
The costs of ERA are not currently fully funded within the PO’ s strategic plan and it
has been assumed that the “gap” will be met through a funding arrangement with ICL
3. ICL/Fujitsu Status and Direction
nN
POL00104333
POL00104333
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
Can PO Ltd get betier value from its relationship with ICL ?
A detailed review of ICL Pathway and Fujitsu’s financial status and future business
direction has been carried out by KPMG. The headline conclusions are
e ICL’s financial performance is poor whilst that of Fujitsu remains strong.
* ICL’s strategy is prudent but will restrict growth/innovation whilst Fujitsu has
strong capability to expand albeit it is over dependent on Asia/Pacific
«# ICL remains well positioned within its core markets, has a trusted brand, not
cutting edge but with some innovative capability
® Fujitsu strongly loyal to ICL but taking greater interest due poor performance.
Analyst vie they'd wanted to sell would have done so by now. ICL as Fujitsu’s
bridgehead into Europe ?
e Horizon key contract now part of Large Contracts Division focused on delivery and
tight cost control which might be at the expense of future capability and innovation
Fujitsu clearly has the resources to deliver another “Horizon” , [CL have an increased
focus on delivery and whilst they have innovated for other clients they have a mixed
record of delivery, may not have sufficient resource of the right kind and need to
change culture.
‘The implications for Post Office Ltd. are that it must get better value from the
relationship. The challenge is whether through a stronger partnership approach PO
Ltd. can draw out the best of ICL’s capability.
4. Legal/Regulatory Constraints
We can extend the contract for 3 years without having to go through a
procurement process
Procurement advice is that non-competitive award of a new contract of similar length
to the original one would breach public sector procurement rules which PO Ltd. is
required to follow. However, a non-competitive extension of the contract of up to 3
years would be allowable provided that there were sound reasons for doing this.
5. 1S Strategy
Horizon will be at the core of our architecture beyond 2005
The review of the IS Strategy concluded that Horizon would continue to form the core
of the retail infrastructure through 2005 and beyond. It proposes, where commercially
viable, to use the developments of other channels ¢.g. kiosks as the basis of
developing alternatives to ICL.
6. Options
3 02/04/01
POL00104333
POL00104333
IN STRICTEST CONFIDEN:
IThe business priority is to change the business not to change suppliers I
The options considered were as follows
* Do Nothing (yet) -The current contract still has 4 years to run. PO Ltd. could
simply allow it to continue for the tinie being, on the basis that a procurement to
obtain a replacement could be carried out nearer to the end of the contract.
« New competition - We could start planning now for a full competition to award a
replacement contract in or before April 2005.
e Truncate current contract - We could plan to terntinate the existing contract early.
This would involve a significant termination fee.
e Extend current contract - An extension of up to 3 years could be made. This would
take the current contract to 2008.
e Renegotiate and extend - As above, but seek significant improvements in the terms
and conditions applying to the contract now in return for the extension including
financing for major projects such as ERA
etailed analysis, description and comparison of the options is at Appendix b.
All of the options which imply replacing ICL. or at least testing the market create a
significant risk. ICL could if they so chose paralyse further developments. Any
delays beyond 2005 would almost certainly require short term extensions which could
be at significant cost. If this was done with serious intent to change partners then all of
the technology based PIU business cases would be difficult if not impossible to cost
in. But above all clse at a time when PO Lid faces change on an unprecedented scale
large amounts of scarce resource would have to be diverted into changing supplier.
This would undoubtedly be at the expense of some of the fundamental business
change necessary for the businesses survival.
An extension on existing terms has little benefit for PO Ltd other than stability, An
extension with renegotiation does provide the business the opportunity to strengthen,
its position with ICL, provide the opportunity to fund ERA which has significant
business benefits and provides an opportunity to develop new ways of working with
ICL including a more innevative approach to development. Negotiations will net
divert scarce resource on anything like the scale that competition would.
Extension with renegotiation, is therefore, the preferred option.
7. Negotiation Objectives
Proposal to grant an extension in return for significant benefits to PO I
Ltd I
The objectives for negotiations are as follo
e Extension of current contract by up to 3 years.
e Spreading of the remaining £120m capital payments over a longer period to create
headroom for fumding new development.
4 02/04/0
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
*
Annual cost including banking and ERA developments over the extended contract
to be no greater than the costs of the core services under the current one.
* funding of ERA development in 2001/2 to aid for through the operating charge
* PON to have greater contro! of the em design; once the ERA design is
implemented PON should control this at system design level as well as business
requirements level
e ICL to partner with other technology companies to ensure that all new
developments are innovative
@ Market pricing
* Incentivisation through some sharing of benefits and risks
8. Negotiation Pian
Negotiation will be based around a plan
Negotiations would be lead by Dave Miller. However, the negotiation objectives
would be agreed by the Executive Board and the negotiating brief by Stuart Sweetman
to ensure that this conformed to the agreed objectives. The outurn of negotiations to
be agreed by the EB if this falls utside the negotiation objectives.
An outline of the draft timetable is shown below. This would have to be agreed up
front with ICL
Agree negotiation objectives in PO. April 2001
Agree negotiation brief April 2001
Approach ICL to initiate negotiations May 2001
Negotiation of heads of agreement June 2001
Uf fails, then switch to contingency plan)
Negotiate full agreement October 2001
Draft and agree new coritract January 2002
9, Conclusion
Extension and renegotiation is recommended on the basis that this will
deliver worthwhile benefits and allow major change to proceed
The Executive Board is invited to agree that negotiations be opened with ICL with the
objectives as outlined above.
Appendix a
Background to the Horizon contract
5 02/04/01
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
1. History
Following various studies into options for payment of social security benefits through
post offices, a decision was taken by Government in 1994 to proceed with a major
project that would both modernise benefit payment and provide counter automation in
all post offices.
Following an extensive procurement exercise, contracts were awarded to ICL Pathway
in May 1996. Known as the Related Agreements, there were three contract with ICL
Pathway - Contract 2 for the payment card, held by the Department of Social Security;
Contract 3 for Post Office automation held by Post Office Counters Ltd.; and the
master Contract I defining the overall framework and terms and conditions held by
DSS and POCL joinily.
These contracts were awarded in accordance with the principles of the Private Finance
Initiative. This meant that significant areas of risk associated with the project and with
benefit fraud prevention were transferred to ICL Pathway; and that payment for the
service was based on transaction volumes. Once the service was live, the payments to
ICL Pathway were underpinned by guaranteed minimum amounts (which equated to
the payments that would be due at around 70% of forecast volumes) and there were
discounted prices for volume growth. However, no payments were due to ICL
Pathway until the service was accepted and in live service.
There were associated contracts between POCL and the DSS. Contract A covered
transaction services ~ that is, analogous services to those previously provided in the
manual environment, but updated to take account of the payment card. This contract
was on normal commercial terms. Contract B covered transmission services, and in
effect allowed POCL to recharge those elements of the Contract 3 services that related
to benefit payment to the DSS, without any mark-up other than a fee to cover contract
management cos’
In addition, POC.
Ireland.
had similar contracts with the Social Security Agency for Northern
There were repeated delays to the development and deployment of the services under
the Related Agreements. This resulted in a re-plan of the project on 1997, and then to
a series of reviews as timescales continued to be failed.
This culminated in a review of the project led by HM Treasury and involving the DSS.
and the DTI (as the Post Office’s sponsor in Government) and a decision by ministers
in early 1999 that they no longer had confidence in the project’s ability to deliver
services in time to support government policy, that the payment card element of the
project should be cancelled, but that automation of post offices should continue.
Terms with ICL to implement this were negotiated by representatives of HM.
Treasury, and a proposal put to the PO Board for endorsement in May 1999. On the
basis of undertakings from DTI that would enable the Post Office to draw on reserves
(not otherwise available to it} to fund the up-front costs of the new contract, a letter
agreement aned between Post Office Counters and ICL Pathway in May 1999,
and following detailed negotiations this was turned into a new contract in July 1999.
6 02/04/01
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
2, Current Contract
‘The new contract between POCL and ICL Pathway, signed in July 1999 and known as
the “Codified Agreement” (because it codified the terms of the May 1999 letter
agreement) was largely derived from those parts of the Related Agreements that were
not concerned with the benefit payment card. However there were significant changes
to the pricing and other terms and conditions.
Payments to ICL Pathway are no longer volume-related (except to a very limited
extent as explained below.) Instead. there are a series of payments related to
Acceptance and physical roll-out that are intended to remunerate ICL Pathway for the
development of the service, and further regular payments to cover operation of the
live service. Incremental development and change is chargeable separately, on a time
and materials basis, agreed case by case through a defined change control process.
The contract runs to 31 March 2005 unless terminated earlier. POCL has the right to
terminate the contract ai any time by giving 12 months notice, but this would result in
significant termination payment to ICL Pathway equating to their unrecovered costs
plus estimated future profits. There are circumstances in which the contract can be
terminated earlier without such a long notice period, and without a termination
payment; these include termination as a result of uncorrected ICL Pathway defaults.
At the end of the contract, or on its earlier termination, POCL has the right to acquire
the assets used by ICL Pathway to provide the contracted services for a nominal
payment of £1. (A higher transfer payment would have applied in the roll-out phase of
the contract, but this is no longer relevant now that ICL, Pathway have received all of
the roll-out payments.)
3. Service Levels
The Codified Agreement specifies a range of service levels that Pathway are to meet
in providing the contracted services. These fall into the following main groups:
a) Training
b) Roll-Out
c) Transaction times
d) Data transfer
¢) Help desk performance
f) Time to fix (field maintenance)
g) Reconciliation
h)} System stability
Groups (a) and (b) are relevant only to the roll-out period. The remainder are relevant
throughout the contract.
Groups (g) and (h) were added as a result of rectification plans for faults found during
the Acceptance of the Core Services Release (CSR). The remainder were included in
the original contract.
“I
92/04/01
POL00104333
POL00104333
IN STRICTEST CONFIDEN!
Generally, service levels are reported monthly in a report prepared by Pathway and
discussed at the Service Review Board. Some service levels have Minimum
Acceptable Thresholds (MATs) and/or Termination Review Thresholds (TRTs}, and
most of these also have mechanisms for calculating liquidated damages to compensate
POCL for losses incurred as a result of performance below the Minimum Accepiable
Threshold level.
If service falls below a TRT during any quarterly reporting period, or below the MAT
for any 3 quarters out of 24. then POCL has the right to terminate the contract. An
alternative course of action in these circumstances is to require Pathway to devise a
rectification plan to correct the sub-standard performance; in that case the right to
terminate would still apply ifno sai tory plan could be agreed.
The right to terminate would not arise if the sub-standard performance by Pathway
was a result of force majeur, or if it had been caused by POCL failing to carry out our
obligations to Pathway.
4..Current Status of Horizon
Roll-Out
Over 95% of the roll-out has now been completed. This is ahead of schedule. There }
are around 600 post offices still to be automated; around 400 of these are expected to I peek
be completed within the next 2-3 months, with the remainder taking longer because \
there are issues (such as moving to new premises) that will take time to resolve. \
Pathway have now achieved all of the roll-out milestones to which payments are
linked; an element of the operating payment is linked to the number of automated post
offices, so there is a limtited price incentive for them to complete the rest (around £100
per post office per month with effect from April 2001); but this is probably less
significant than the savings that they will make by closing down their implementation
operation and saving the management overhead they are incurring on it. There are
some indications that completion of the roll-out has been getting reduced management
attention in Pathway recently, and that as a result the “headroom” that has been
created by previous over-performance relative to the contractual schedule will be used
up over the next few weeks.
Development of the Core Services
The contract with Pathway includes defined services (the “Core Services”) to be
provided at the contracted price. These services are being provided within 2 main
releases - CSR and CSR+. Both of these have now been delivered; however there are
anumber of “hang-outs” from the Core Services that have not yet been completed.
Automated Payment Service client connections have not yet been established for all
the clients; this is scheduled to be completed around June 2001.
There are known problems im the CSR+ release as inmplements: these are due to be
rectified, mainly in a maintenance release, “M1”, due for roll-out in April/May 2001.
Service Performance
8 02/64/04
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
There have been problems with performance against service levels in relation to:
time to fix
data transfer
help desk performance
In the first two cases, a number of MATs were failed in each of the first three quarters
following Acceptance of the ice. (There are no MATs for help desk performance;
various targets were failed over the sam nescale, but with less contractual
significance.}
Asa result of this, POCL required Pathway to develop rectification plans to bring
performance up to the required standard. Pathway’s response is still being discussed:
their proposals in relation to data transfer service levels would change the contracted
service levels and are not currently acceptable; the proposals on the other failed
service seem likely to lead to acceptable improvement plans.
Financials
ICL Pathway have achieved the major roll-out milestones for the roll-out payments.
They have received approximately £440m (ex VAT) from the contract to date, and
will receive approximately £115m (ex VAT) per annum from April 2001 for the core <
services; this excludes cost of chang: fc i i \
Appendix B
Options
1. Do Nothing (yet)
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
The current contract still has 4 years to rin. POCL could simply allow it to continue
for the time being, on the basis that a procurement to obtain a replacement could be
carried out nearer to the end of the contract.
Pros - defers the potentially disruptive effect of commercial negotiations that may
prove difficult and that may make if more, rather than less difficult to achieve rapid
delivery of the new developments needed.
Cons - a new procurement may take longer than currently anticipated (PO Purchasing
estimate 18 months) and a 12-18 month roll-out for any new supplier would
potentially be required in addition to any development time. Thus the minimum lead
time from starting the procurement to completing roll-out of replacement services is
likely to be 3 years. Also, it will become increasingly difficult to reach agreement on
terms for incremental development with Pathway when the future of their contract is
in doubt. New developments would be increasingly difficult to justify in the interim,
since they would have to be cost justified over the existing contract, and then paid for
a second time on the replacement system. The effort required to put in place a new
contract and service would be considerable and a diversion from change activity.
2. New competition
We could start planning now for a full conipetition to award a replacement contract in
or before April 2005.
Pras - maximises price competition and opens up the possibility of making a step
change in capability and cost. Minimises any risk of challenge on procurement
regulation.
Cons - Likely to distract Pathway and the Post Office from current developments to
getting their bid together: also likely to be very difficult to manage the Pathway
relationship if they believe they are unlikely to win. Also, it may be difficult to
specify the service required given the uncertainty about the future shape of the
network given that the PIU programme is at an early stage, and that the government
guarantee on the social network is due for review in 2006. New developments would
be increasingly difficult to justify in the interim, since they would have to be cost
justified over the existing contract, and then paid for a second time on the replacement
system.
3. Traneate current contract
We could plan to terminate the existing contract early. This would involve a
significant termination fee.
Pros - allows benefits of a new contract with a new supplier to be achieved early.
Minimises period of dependency on a dissatisfied existing supplier.
Cons - costly. Even if a new supplier was prepared to finance the exit fee, this would
in effect be recharged to POCL over the subsequent contract. very difficult to manage
Pathway during the notice period, and this is a time in which key business
developments are required, Would put delivery of banking and GGP at risk.
10 02/04/01
POL00104333
POL00104333
IN STRICTEST CONFIDENCE
4, Extend current contract
An extension of up to 3 years could be made. This would take the current contract to
2008.
Pros - likely to be attractive to ICL, and therefore should maximise their co-operation
on new developments during the next few years. Avoids disruption of major
procurement exercise during a period in which major business change has to be
achieved.
Cons - may not achieve as low a price as would be obtained by competition.
Continuation of problems being experienced with the current contract in relation to
visibility and control of developments, and high costs of incremental change. Existing
hardware may become unreliable if not replaced during the extension period, and that
would make a subsequent conipetition less attractive to other suppliers.
5, Renegotiate and extend
As above, but seek significant improvements in. the terms and conditions applying to
the contract now in return for the extension.
Pros - as above, plus opportunity to improve PON cask flow in the intermediate
period to 2005.
Cons - may prove a difficult negotiation. [f unsuccessful, it may be more difficult to
manage the relationship with [CL during the remainder of the current contract. ICL
may not have the financial headroom to do the kind of deal we need.
6. Comparison of Options
The following table compares the above 5 options in terms of a number of criteria on
the following scale:
1 Option meets criterion in full
2 Option meets criterion to a significant extent
3 Option fails to meet criterion to a significant extent
4 Option does not meet the criterion
Sa B2
New
yet competition
Supports NB and UB 2 3 3 2 1
Supports ERA. 3 3 4 2 1
Supports GGP- 2 3 3 2 1
Supports Network 2 3 2 2 1
Transformation
PO has adequate control of 3 2 3 2
design and introduction of
new developments
1 02/04/01
IN STRICTEST CONFIDENCE
POL00104333
POL00104333
$3 8.2
Bo nothing
yet
Creates financial headroom 4 4 2
for new developments in
2001-2004
Reduces PON system costs 2 1 3 2
after 2005
Provides business continuity I 4 3 i 1
at end of current contract
12 02/04/01