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RMH(06)8™
RMH06/133 - 151
ROYAL MAIL HOLDINGS pic
(Company no. 4074919)
Minutes of the meeting of the Board of Directors
held at 148 Old 1 j
Present:
Allan Leighton
David Burden
Alan Cook
Adam Crozier
David Fish
lan Griffiths
Richard Handover
Sir Mike Hodgkinson
Tony McCarthy
John Neill
Baroness Prosser
Bob Wigley
Apologies:
Helen Weir
In attendance:
Jonathan Evans
Also present:
Rico Back
Frank Schinella
Alex Smith
Doug Evans
Mark Higson
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Chairman
Group Technology Director
Managing Director, Post Office Ltd
Group Chief Executive
Non-Executive Director
Managing Director, Royal Mail Letters
Non-Executive Director
Non-Executive Director
Group Director, People and Organisational Development
Non-Executive Director
Non-Executive Director
Non-Executive Director (by telephone)
Non-Executive Director
Company Secretary
Chief Executive, GLS
Acting Group Finance Director
Group Strategy Director, for RMH06/143 ~ 144.
General Counsel, for RMH06/143 — 144
Deputy Chief Executive, Shareholder Executive, for RMH06/143
(part)
MINUTES OF PREVIOUS MEETING RMH(06)7™
The minutes of the meeting held on 4 July 2006 were approved
and signed.
MATTERS ARISING — RMH(06)81
The Board noted the status report;
Royal Mail Way (RMH06/79(c)): the Board noted that a progress
report had been due to be presented to this meeting. lan
Griffiths explained that the reason for deferring the item was the
non-availability of key people involved in the project. There
would be a full report-back on progress in September;
!ai stamp programme (RMHO06/124(b)): lan Griffiths
reported that the stamp programme had been reviewed in the
light of the Board’s comments at the previous meeting. Plans
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were being drawn up to increase the number of issues in
2006/07, and further work was in hand to enhance the diversity
of subjects in the 2008 programme. Margaret Prosser observed
that 2008 would mark a significant anniversary of women’s
suffrage, and wondered whether this was being commemorated
in the programme. lan Griffiths undertook to find out and report
back;
Oil leakage (RMHO06/116(f)): the Board noted lan Griffiths’ report
in response to the points made at the previous meeting. lan
Griffiths confirmed that the complete removal of fuel cards would
be impractical due to the wide geographical spread of vehicles,
but their usage would continue to be tightly controlled;
Special delivery (RMH06/120(c)): the Board noted lan Griffiths’
report which showed the current profile of special delivery
business, and the main reasons for volume variances.
OTHER MINUTES.
The Board noted the minutes of the meetings of
the Group Executive Team of 20 June 2006
the Audit and Risk Committee of 6 June 2006
the Pensions sub-Committee of 16 June 2006
the Post Office Ltd Board of 28 June 2006.
CHAIRMAN’S BUSINESS
The Chairman had no business other than that elsewhere on the
agenda.
REPORTS FROM CHAIRS OF BOARD COMMITTEES
Nomination Committee: Richard Handover reported that he had
agreed on behalf of the Committee that lan Duncan, when he
joined the Company on 1 September 2006, would become a
member of the GLS Supervisory Board, in addition to Allan
Leighton and Jonathan Evans. The Board endorsed this
appointment. Richard Handover further explained that work was
continuing to find suitable candidates for the director-level
vacancies in Post Office Ltd;
Remuneration Committee: David Fish reported that while
Government agreement had not yet been secured to the
proposed base pay and annual bonus arrangements, he did not
anticipate there would be any major difficulty. However in
respect of the LTIP, there were still some important issues of
principle remaining to be resolved which he was continuing to
pursue with Government officials.
EXECUTIVE DIRECTORS’ REPORTS
The Board noted the executive directors’ reports;
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Royal Mail Letters: the Board expressed disquiet about the rate
of accidents involving vehicles, and coupled with this was a
concern that the current system for allocating vehicles to drivers
led to higher levels of vehicle damage because drivers felt little
sense of ownership of the vehicles they drove. lan Griffiths
agreed to bring to a future meeting an outline plan for improving
this performance;
the Board recalled that over a year had passed since the
completion of the Transport Review. lan Griffiths was asked to
Provide for the Board at a future meeting a critique of the
effectiveness of the transport changes;
GLS: Rico Back reported that performance levels were
remaining good, although revenue had been under pressure due
mainly to a downturn in economic activity in continental Europe
arising from recent high temperatures. The excessive heat had
also been a contributory factor to the capital programme falling
behind schedule, although it was expected that lost time would
be caught up in the rest of the year. He was also continuing to
pursue the acquisition opportunities he had outlined at previous
meetings;
Post Office Ltd: Alan Cook reported that sales in POL were
slightly behind target, and that a sales campaign would soon be
Starting to address this shortfall. Agreement with the CWU had
been reached for a pay settlement in the Cash in Transit unit,
while the options for reaching a settlement in the rest of POL
now needed to be considered in the light of the Royal Mail
Letters settlement. The announcement of proposals to franchise
six directly-managed branches in stores of WHSmith was
continuing to cause some union dissent and minor
demonstrations: however Alan Cook was in frequent dialogue
with the Chief Executive of WHSmith, who was continuing to be
positive about the venture;
work had been continuing on the challenges to the POL strategy
made at the Board's July strategy meeting, and these would
return to be discussed further in September;
the Chairman raised the issue of ISA Retail, the company
appointed to supply retail products to the POL network, about
which there had recently been some negative press coverage.
While disappointed by the appearance of the news story, Alan
Cook stated that he had some reservations about the
appropriateness of some of the product range and was reviewing
it. He surmised that the news story had probably emerged from
a leak from a disaffected ex-employee of POL;
Technology: David Burden informed the Board of the
considerable progress that was being made with the
development of a semi-automatic system for sorting packets at
Gatwick mail centre;
People and Organisational Development: Tony McCarthy
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reported that following the last board meeting, his team had been
making plans for a major launch of the employee share scheme.
While the timing of such a launch was still uncertain, action was
going ahead with installing televisual IT equipment in all work
locations to provide a rapid and effective internal
communications channel;
Parcelforce Worldwide: Adam Crozier reported that Vanessa
Leeson had returned that week following a period of three
months’ recuperation after a hospital operation. In her absence
David Smith, the PFWW Finance Director, had very
commendably led the executive team in ensuring that
Parcelforce performance remained well on track;
Adam Crozier informed the Board that he had recently been in
Korea to discuss whether there may be an opportunity for a
commercial link-up with Japan Post for handling parcels
business between the Far East and Europe. Talks between
Japan Post and Fedex had recently been concluded without
agreement, which may give scope for a venture via GLS. He
would keep the Board informed of progress.
FINANCE DIRECTOR'S REPORT
The Board noted Frank Schinella’s report and presentation. The
results for the first quarter of 2006/07 showed that Group
operating profit before exceptional items was £18m, some £15m
favourable to budget and £59m adverse to the prior year. The
results showed a continuing and disturbing downward trend in
revenue, mainly in the Letters business, where there was now a
net £70m revenue risk against budget;
of further concern was the position on productivity levels: while
work hours had been adjusted to correspond with reduced traffic
levels, the cost per work hour had increased, leading to unit
costs rising by 4.6% in the year to date;
overall the analysis showed net profit risks of £31-36m for the
Group as a whole. The Group Executive Team was addressing
these risks, and were initiating actions to reduce the cost base
accordingly;
Frank Schinella updated the Board on the work being done with
the pension fund Trustee to explore options for de-risking the
fund. He was still searching for an independent source of expert
advice on de-risking strategies.
POST OFFICE LTD: RURAL NETWORK PAYMENTS —
RMH(06)83
The Board noted Frank Schinella’s paper which set out an
analysis of the merits of treating rural network payments as
revenue or capital. The main benefit of revenue treatment was
an increase in POL’s accounting profit and that it gave a better
reflection of the nature of services provided to Government: on
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the other hand revenue treatment would incur an additional tax
liability of some £53m discounted over ten years. After some
discussion the Board:
agreed to treat the payments as capital;
agreed to keep the matter under review to ensure that this
decision would not adversely impact on other areas of balance
sheet restructuring work. It was also recognised that in different
future circumstances the arguments for revenue treatment may
have more weight.
INVESTMENT RETURNS — RMH(06)82
The Board noted Frank Schinella’s discussion paper on possible
changes to hurdle rates for investment projects. The paper was
in response to concerns expressed by the Board earlier in the
year about what it saw as the comparatively unchallenging
nature of the current hurdle rate regime;
in discussion, the Board considered that the proposed increase
in the overall average hurdle rate from 11% to 12% did not go
anywhere near far enough to provide the necessary challenge to
the Company in its investment project performance. Many
directors considered that an overall rate of nearer 30% would be
more appropriate. As the Board had seen earlier in the meeting,
productivity trends were worryingly adverse: therefore much
tougher target returns for projects generating manpower
efficiency gains were needed;
the Board acknowledged that it was appropriate for different
types of project to be measured against different hurdle rates.
Investment needed for statutory or health and safety reasons
could be justified with low or zero rates of return, while
manpower efficiency projects should seek payback within a year.
The key point for the Board was that as the Company was about
to embark on a major infrastructure investment programme, it
was vital that investment projects were implemented in a manner
which resulted in step-change improvements in labour
productivity;
while supporting the call for tougher hurdle rates, Bob Wigley
cautioned that if higher rates were to be approved, then care
needed to be taken to understand the implications for the
regulatory environment. He recommended trying to establish the
returns achieved by peer group companies, and further asked for
the Board to see more results of post-investment reviews of
investment projects;
in conclusion, the Board invited management to consider the
points raised in the discussion, and to return to a future meeting
with a revised proposition. The Board agreed that no changes
should be made to the current methodology for assessing and
authorising investment projects in GLS.
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INDUSTRIAL RELATIONS UPDATE
Tony McCarthy gave a presentation to the Board on the state of
industrial relations following the agreement reached with the
CWU on 25 July on pay and working practice changes in Royal
Mail Letters;
the agreement itself, which included a 2.9% consolidated pay
increase, and an extension of the productivity scheme until the
end of March 2007, provided a way forward for testing new ways
of working at sites trialling new equipment, which had previously
been embargoed; it paved the way for a new agreement, to be
reached within 12 weeks, for removing the current limits on the
handling of unaddressed mail; and it would lead to a trial of a
new attendance procedure, also within 12 weeks. The Company
had reaffirmed some previous commitments, dependent on
satisfactory resolution of Government's future funding of the
Company, to continue to manage job losses by voluntary means,
and for no-one to be compelled to move from full- to part-time
working. In addition there was an agreement to joint
management and union training, and to agree a new industrial
relations framework by the end of 2006. The overall agreement
was now subject to a CWU membership ballot;
the tortuous progress of the union negotiations had revealed a
good deal about the current state of the union and its leadership.
While the basic agreement had been struck at a high-level
meeting with the CWU General Secretary in June, it had taken a
further month for the union executive to accept the position.
There was still a degree of dissent amongst some executive
council members, which in turn was expected to lead to potential
difficulties on the ground in coming months in implementing the
various elements of the agreement. Overall the union leadership
had shown itself as divided, with no one person able to exert
influence to make decisions;
in Tony McCarthy's view, there were also lessons for the
Company. He had been dismayed to learn of a number of
separate negotiations with the union taking place at the same
time — an issue he was addressing. He also felt that the
negotiations had been conducted at too high a level in the
Company;
looking ahead, even if as expected the union secured approval
to the pay deal in its membership ballot, there were a number of
potentially serious industrial relations flashpoints anticipated in
the coming months. Some of these related to the change
elements of the recent agreement, while there were a number of
others in areas where the Company needed to make change —
for example the closure of Liverpool airport mails facility, the
closure of some mail centres, and the introduction of a vehicle
tracking system.
In subsequent discussion the Board fully supported the need to
progress the changes in working practices that were needed.
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However in the view of many directors the Company was not
well-prepared to mount an effective campaign to introduce
change in the face of union opposition, notwithstanding the
extreme and unrepresentative positions being taken by some of
the CWU leadership. In particular the calibre of front-line
managers was not generally adequate for seeing through the
degree of change necessary. In the Chairman's view, which the
Board fully supported, this implied that change needed to be
introduced by stealth rather than by direct confrontation, and
every effort should be made to avoid making unintentional gifts
to the union of “causes” around which it could unite its
membership. On the other hand there needed to be some
visible signs of the need for change ~ for instance the closure of
some depots ~ to reinforce the message that competition was
hitting the Business and that change was necessary;
a potentially limiting factor was the likely response of
Government to the prospect of a prolonged period of industrial
unrest. Recent events had cast some doubt on Ministers’ ability
to support the Company in the face of political pressure: the
Board should therefore be wary of assuming a level of support
that might turn out to be transitory. In David Fish’s view this
raised a potentially serious problem for the Company: change
introduced incrementally could lead to the Company being
seriously unprofitable in a short time, which in turn could result in
the Company needing to face even more drastic recovery action.
There needed to be a serious debate with Government to ensure
that they fully appreciated the scale and speed of change
needed to transform the Company, and the level of support they
would be called upon to give;
the Board recognised that industrial relations was a key issue to
which it would need to return in depth in coming months, and
that it was closely allied to the stance the Government would
take on the Company's plans for an employee share scheme. In
the meantime, Tony McCarthy was asked to map out a plan of
‘the potential industrial action flashpoints, scenarios, and possible
management responses, in readiness for a further discussion at
the Board meeting in September.
GOVERNMENT FUNDING AND EMPLOYEE SHARE SCHEME
Alex Smith presented to the Board a summary of the latest
position with the discussions with Government about the funding
package and the proposed introduction of an employee share
scheme, The background to this latest discussion was the news
that for political reasons it would not be until November 2006 that
the Secretary of State would be able to provide an answer on
whether the Government would support a real employee share
scheme;
in his presentation Alex Smith reminded the Board that the
investment case put to Government in February 2006 had the
capacity to create over £4billion of shareholder value.
Underlying the investment case was a radical transformation of
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Royal Mail which, without some effective means of overcoming
union and workforce attitudes of opposition to change, would fail
to be delivered;
delay in finalising the funding package, and particularly in getting
a clear Government response to the share scheme proposal,
was already resulting in the Group's slipping behind schedule in
implementing the transformation. On the other hand proceeding
with the transformation on the assumption that Government
would in the end support a real employee share scheme would
carry considerable risk for the Company and the Board;
management had developed a transformation plan for the Letters
Business that it believed was deliverable without a real employee
share scheme. This showed a £3billion reduction in the market
value of the Company compared with the investment case, with
the potential financial stake for each employee reduced from
£5000 to £1000, rendering even a phantom share scheme
unviable. Furthermore such a reduction in the pace and scale of
transformation, and the lower returns from it, could lead to the
Pension Fund Trustee having to consider abandoning its
agreement to a 17-year deficit repair period for a shorter period
nearer to the Pension Regulator's benchmark of ten years. This
in turn, because of the resultant higher annual payments, could
lead to the Group becoming cash-flow insolvent. In that event
the Board would need to consider developing a “manage for
cash’ case, requiring a confrontational approach with workforce
and unions to force change through;
this analysis therefore suggested that, if the Board considered
that there was a reasonable prospect of getting Government
agreement to a real employee share scheme in November, the
best course for the Board to take was:
¢ to confirm to Government that the Board intended to pursue
the delayed transformation plan, but solely at Government's
risk
e to release none of the Mails Reserve, other than that
contractually committed, to fund POL and require new
funding for Letters until November
* to demonstrate to Government the consequences of their
failing to meet the November deadline in terms of possible
Group insolvency, depending on the stance of the Trustee,
and the disruption and political complexity of following a
“manage for cash” route
* to work with the DTI to prepare a compelling case for an
employee share scheme.
In subsequent discussion, the Board expressed its great
disappointment that the Secretary of State had been unable to
support the Company's proposal for a share scheme at the
current time, and that it would be necessary to wait a further
three or more months before getting a decision. Nevertheless
the Board, having considered the analysis in the presentation,
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reluctantly came to the conclusion that it should support the
proposed approach, recognising that it was the best option
available and therefore in the interests of the Company to pursue
it;
in Bob Wigley's view it would be important to relay the Board’s
decision and opinions directly to Ministers in writing as well as to
officials. He considered that officials were supporting the
Board's view, and it was Ministers who needed persuading. It
was therefore important that Ministers fully understood the
Board's view, and the risks the Government would be taking in
not supporting management's preferred proposals. Also the
Government should be reminded that the current directors had
agreed to serve on the basis that the Government wished them
to turn the Company into a world-class operation: Government
delays in making decisions were jeopardising this;
in Margaret Prosser's view, based in part on a conversation she
and the Chairman had had with the Secretary of State in the
previous month, the Secretary of State was personally
supportive of the need for the employee share scheme, but the
political environment made a public expression of support at the
current time difficult. In her view the Company should be doing
all it could by way of an influencing plan to ensure that the key
people who would be instrumental in Government coming to a
decision were fully briefed on the Company's rationale for a
share scheme: her experience to date was that the Company
was considerably behind the game, and needed to address this
urgently. Other directors supported this proposal, adding that
care should be taken not to over-dramatise the implications of
failure to secure agreement to a share scheme, as this would be
counter-productive;
the Chairman concluded that the clear view of the Board was to
proceed with the proposal as set out in Alex Smith's
presentation, but to consider further, partly in the light of the
forthcoming appearance of Mark Higson at the Board, how best
to respond to Government.
Mark Higson joined the meeting.
The Chairman welcomed Mark Higson, and invited him to give
his assessment of the Government's position in respect of the
proposed employee share scheme;
Mark Higson said that in his personal view, the Government
would give its agreement to an employee share scheme in
November. The reasons for his confidence were that by then the
political environment should allow a decision to be made more
on its commercial merits; but fundamentally he believed that
Government had no real alternative. It could fund the Business
on a non-commercial basis, but that would simply prove the
unions and workforce that the Government was prepared to bail
the Company out; to pursue a plan that relied on confrontational
change would not be politically attractive; or Government could
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change the management of the Company to some who would be
able to manage without an employee share scheme. Backing a
share scheme was preferable to any of these other options.
Furthermore the share scheme had the full backing of the
Shareholder Executive, and he felt it would be easier to secure
Treasury agreement to a share scheme than it was to the
funding package. In Mark Higson’s view, the key action now
would be to spend time working up a full and compelling case for
employee shares to make the decision as easy as possible in
November;
Mark Higson added that Government was ready to sanction the
Post Office Ltd Subscription Agreement, the terms of which
would leave the Mails Reserve intact, but needed a positive
indication from the Board that it would work with the November
timetable,
In subsequent discussion the Board acknowledged the sterling
efforts that Mark Higson had made to try to bring Government to
a position of being able to agree the employee share scheme.
The Board's concern was that the delay could be interpreted as
a lack of commitment on the part of Government to the Board's
plans to turn Royal Mail into a world-class company. The Board
questioned whether Ministers were sufficiently aware of the
challenges facing the Company, particularly the impact of
competition: in effect the mail service in the UK was being
privatised, and it was crucial that the Government and the Board
had a shared and detailed vision of what this meant for the future
of Royal Mail. As Government had agreed to invest in the
Company, the best way for the Government to mitigate the risks
of that investment was to back the Company's management in
taking the tough decisions necessary. Mark Higson agreed with
this analysis, and suggested that it would be necessary to
engage Ministers face-to-face in a discussion to ensure that the
issues were well understood;
the Chairman expressed his concern that a decision in
November, even if it was positive and clear-cut, would still mean
that the Company had lost eight months of the year. His faith in
Ministers holding to deadlines had also been weakened by
recent events, and it was vital that there was a climate of trust
between the Board and the Government. Mark Higson agreed,
and reiterated his view that “providing we all play our cards
right”, Ministers will make a positive decision on employee
shares in November;
the Chairman thanked Mark Higson for attending the meeting,
and for the great efforts he was making.
Mark Higson left the meeting.
In subsequent discussion the Board concluded that the
discussion with Mark Higson had confirmed its view that the right
course of action would be as set out in Alex Smith's
presentation. The Board therefore agreed the actions at (e)
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above, and further agreed:
* that the Chairman should write to the Secretary of State,
setting out the Board's decisions and views
(A copy of the letter, sent on 4 August 2006, is attached to
these minutes)
* and that Adam Crozier should prepare a communications
and influencing plan to promote the employee share scheme.
POST OFFICE LTD SHORT-TERM FUNDING ~ RMH(06)84
The Board noted Frank Schinella’s paper, which updated the
Board on the current status of the discussions with Government
‘on the funding of Post Office Ltd, and proposed that the Board
gave its approval to a Subscription Agreement, as negotiated
with Government for the purposes of funding Post Office Ltd in
the short term;
after some discussion, and taking into account the views
expressed earlier in the meeting in the wider context of the other
issues being discussed with Government, the Board supported
going ahead with the Subscription Agreement. However the
Board considered that it would be preferable to inform
Government of this decision after the letter to the Secretary of
State about the employee share scheme, as discussed in the
previous item, had been received by Government. The Board:
approved the Subscription Agreement;
authorised Jonathan Evans to arrange the requisite board and
other meetings to enact the agreement, including a meeting to
issue new shares in the Company;
delegated to Jonathan Evans the authority to sign the
Subscription Agreement on behalf of the Company, Royal Mail
Group pic and Post Office Ltd;
delegated to the Group Finance Director the authority to
negotiate the form in which the remaining contributions in
2006/07 and 2007/08 would be made by Government, as set out
in the paper.
POST OFFICE LTD: REPLACEMENT OF HORIZON ~
RMH(06)85
The Board noted Alan Cook's paper, which recalled that the
Board on 27 April 2006 had approved Post Office Ltd's plan to
conclude contract negotiations with Fujitsu with regard to the
replacement of the Horizon Electronic Point of Sale system, and
had authorised additional interim funding of £25m to take the
total authorised sum to £35m. This paper sought final authority
to sign the contract with Fujitsu. After due consideration the
Board:
approved Post Office Lid’s pian to conclude negotiations with
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Fujitsu, and
delegated authority to the Managing Director of Post Office Ltd to
sign the contract, subject to the satisfactory conclusion of the
final negotiations with Fujitsu within the Board’s authorised sum.
CUSTOMER INSIGHT
This presentation was deferred to a future meeting.
REGULATION REPORT — RMH(06)88
The Board noted the report.
QUARTERLY INVESTMENT REPORT — RMH(06)89
The Board noted the report.
DIVERSITY AND INCLUSION QUARTERLY REPORT -
RMH(06)90
The Board noted the paper, and after discussion noted that
management was pursuing the action outlined in the paper.
COMPANY SECRETARY’S REPORT — RMH(06)91
The Board noted the report.
CLOSE
In the absence of any further business, the Chairman closed the
meeting. The next meeting was scheduled for 5 September
2006 at 148 Old Street, London.
GRO
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