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Horizon Contract Amendment
Introduction
1. Post Office Ltd has developed an IT strategy which will:
© Significantly reduce running costs over time
¢ Simplify its business processes.
¢ Align to its business proposition.
2. There is a target to reduce this year’s Horizon spend by £15m with further annual reductions.
@ 3. This is the first of a series of strategic initiatives that will be presented to the Board for
approval.
4. Post Office Ltd has carried out a formal market-based assessment of the options for either
extending the Horizon contract with Fujitsu Services or undertaking a competitive procurement
of a replacement system.
5. After in depth negotiations (with strong competition) from IBM and EDS, Fujitsu Services has
produced a compelling proposal when compared with the alternatives.
6. Post Office Ltd has agreed non-binding Heads of Agreement with Fujitsu Services that would
extend the Horizon contract till March 2010, resulting in a contract cost reduction of £27m this
year with an overall revenue reduction of £165m over the life of the new contract compared to
extending the existing agreement,
7. This paper seeks approval to proceed to contract with Fujitsu Services on this basis.
€ Background
I We cannot afford Horizon as it stands.
8. Horizon is Post Office Ltd’s core automation system, developed and run by Fujitsu Services
(formerly ICL). The system was originally designed for a Benefits Agency project under the PFI
in 1996, This was replaced by a standard contract in 1999 which runs to March 2005.
9. Banking was added to the contract in March 2002.
10. The service provided has been good, though expensive to run, and slow and costly to change.
11. Spend on IT is way above industry norms — Horizon is our largest item of IT expenditure (cirea
£115m p.a.)
The Fujitsu Services Proposal
In Strictest Confidence
Li We gain greater contr ‘ol at reduc ed I e
12.
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14.
lee
16.
17,
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Scope of Services:
* The proposed contract includes the existing Horizon services (including Banking).
¢ Fujitsu Services will have the opportunity to bid for new product developments in a
competitive environment.
© Post Office Ltd will be able to exploit, new technologies from other business partners.
Fujitsu Services will integrate standard 3 party applications into the Horizon platform.
¢ There will be a move to open book costing, making charging more visible. Periodic
benchmarking of major services will take place, with prices to be adjusted downwards as
appropriate.
¢ There will be a move to risk management (rather than avoidance) with associated reduction
of Fujitsu Services’ liabilities (being reviewed with Group Audit).
Operational Service:
e Help Desk, Maintenance Services and Data Centre operations will be simplified and
rationalised. This will result in some reductions in service levels, but in line with normal
commercial levels.
e A new Broadband data communications network (ADSL) will be introduced - besides
reducing costs it will provide greater capacity to each branch.
. Development Service:
The infrastructure will be simplified to reduce costs and to improve development timescales.
There will be a reduction in headcount by approximately 40% over the first 3 years of the new
contract. Half of the time of the remaining team will be dedicated to supporting the service, the
other half available for new developments at no extra cost.
Governance, Risk Management and Ways of Working:
There will be a more collaborative style of working, based on trust and risk management (rather
than avoidance). Post Office Ltd will have control of the strategic direction and framework
within which Fujitsu Services will operate. Fujitsu Services will manage the delivery of services
within the framework. Fujitsu Services will be encouraged to bring new ideas and opportunities
to Post Office Ltd. A clear governance structure will be set up, with a number of joint forums
with clear accountabilities between the two companies.
Charging Dependencies:
Key dependencies are:
e Signing contract with Fujitsu Services (Current year benefits assume agreement by
Christmas 2002.)
¢ Reducing branch numbers (in line with network re-invention).
Further Opportunities:
The preferred option business case is based on worst-case assumptions in several areas. The
total cost in NPV terms (based on an 11% discount rate) of these assumptions is approximately
£85m. Careful management of these areas could lead to these costs being reduced by up to NPV
£55m.
To achieve this particular attention will be given to the following:
¢ Simplifying end-to-end processes, This will result in a reduction of Fujitsu Services’ charge
for current services (guaranteed under the terms of the new agreement) plus further internal
In Strictest Confidence
The Fujitsu Services Proposal
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12.
14.
Scope of Services:
* The proposed contract includes the existing Horizon services (including Banking).
* Fujitsu Services will have the opportunity to bid for new product developments in a
competitive environment.
* Post Office Ltd will be able to exploit new technologies from other business partners.
Fujitsu Services will integrate standard 3" party applications into the Horizon platform.
¢ There will be a move to open book costing, making charging more visible. Periodic
benchmarking of major services will take place, with prices to be adjusted downwards as
appropriate.
* There will be a move to risk management (rather than avoidance) with associated reduction
of Fujitsu Services’ liabilities (being reviewed with Group Audit).
. Operational Service:
¢ Help Desk, Maintenance Services and Data Centre operations will be simplified and
rationalised. This will result in some reductions in service levels, but in line with normal
commercial levels.
« A new Broadband data communications network (ADSL) will be introduced - besides
reducing costs it will provide greater capacity to each branch.
Development Service:
The infrastructure will be simplified to reduce costs and to improve development timescales.
There will be a reduction in headcount by approximately 40% over the first 3 years of the new
contract. Half of the time of the remaining team will be dedicated to supporting the service, the
other half available for new developments at no extra cost.
Governance, Risk Management and Ways of Working:
There will be a more collaborative style of working, based on trust and risk management (rather
than avoidance). Post Office Ltd will have control of the strategic direction and framework
within which Fujitsu Services will operate. Fujitsu Services will manage the delivery of services
within the framework. Fujitsu Services will be encouraged to bring new ideas and opportunities
to Post Office Ltd. A clear governance structure will be set up, with a number of joint forums
with clear accountabilities between the two companies.
Charging Dependencies:
Key dependencies are:
* Signing contract with Fujitsu Services (Current year benefits assume agreement by
Christmas 2002.)
* Reducing branch numbers (in line with network re-invention).
Further Opportunities
The preferred option business case is based on worst-case assumptions in several areas. The
total cost in NPV terms (based on an 11% discount rate) of these assumptions is approximately
£$5m. Careful management of these areas could lead to these costs being reduced by up to NPV
£53m.
To achieve this particular attention will be given to the following:
* Simplifying end-to-end processes. This will result in a reduction of Fujitsu Services’ charge
for current services (guaranteed under the terms of the new agreement) plus further internal
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savings in Post Office Ltd. This is a key component of the Post Office Ltd Business Plan.
The investment required to do this (circa £30m, of which it is anticipated £14m could be
provided from the prepaid capacity in this contract) will be the subject of a further business
case.
© Maximising use of the prepaid systems integration capacity under the new agreement
* Introduction of a “lights out” operation at one of the existing data centres.
Additionally, the business case assumes minimum rollout of Broadband in the UK. Further
significant reductions are available (up to £3m p.a.) if BT achieves its nationwide plans.
Other Options
Market Test confirms that Fujitsu Services’ proposition is competitive and overall much cheaper
than moving to a new supplier.
The following options were considered and rejected.
18. Option 1: Do nothing —extend the current contractual terms with Fujitsu Services in 2005.
This was rejected because:
* there are no cost reductions until, at the earliest, 2005
© there is a major risk to business continuity.
19. Option 2: Contract with new suppliers
A market test was carried out with two of our current major IT suppliers. The solutions they
outlined were both technically feasible, and comparable in price.
20. This option was rejected because:
* costs over the contract life were significantly higher than the Fujitsu Services proposition
* there were no cost reductions this year
«there is a major risk to business continuity during any cutover
© system changes needed to support business plans would be delayed by 2 years.
See annex A for financial details of options.
Benefits of preferred option
I We can afford it within current Busi
21, Financial
* Yields an NPV (before tax and based on a [1% Test Discount Rate), that is £93m better than
option I and £60m better than option 2.
* Significant reductions in annual cash flows achieved (£27m this year).
«* Asset maximisation ~ the infrastructure will be fully exploited.
22. Non-Financial
* Provides IT capability to deliver the Post Office Ltd Business Plan
Commitment to simplify systems
Move to a more open architecture
© Improves Speed to Market
Faster speed to market due to improved, simplified development processes and a
simplified technical architecture.
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¢ Lowest risk option to business continuity and banking deployment ®
- Builds on current service, no major upheaval
- Secures banking till 2010 (alignment with government contracts).
© Current service management and development performance has been good.
- Fujitsu services operations proven and to date they have delivered their part of the
Banking project on time.
23. Delivering the Benefits.
¢ Financial benefits will be delivered through the contract price.
¢ Non-Financial benefits achieved through agreed governance model and new Post Office Ltd
organisation.
Risks
I Some significant changes — needs careful management. I
24. Operational ®
e Service levels will be reduced to be ‘fit for purpose’. These changes will impact
postmasters, Head Office staff, and clients, who may see it as a deterioration in service
« There will be a number of significant business process and technical changes over the next
few years that will require careful management.
25. Relationship
e Post Office Ltd and Fujitsu Services revert to type - new ways of working are not
implemented effectively.
Timetable
Post Office Ltd EC 3" Dec 02
Royal Mail Group Board 16th Dec 02
Contract Signing 20" Dec 02
Contract Implementation From Jan 03
£17.6m discount 31st Mar 03 r)
Conclusion
26. The Fujitsu Services proposal provides the cost reductions that the business needs. It is
significantly cheaper and is a much lower risk than the other options available.
The Board is asked to agree and authorise the recommendation.
David Mills
December 2002
Analysis of Fujitsu Numbers - inc VAT
Option a8 Current contract costs i
Capital/Balance sheet funded
Availability fees inc VAT
Capital expenditure - Banking
Capital expenditure - DR Cards
Total capital/balance sheet funding
Non recurring revenue/development
Banking development *
Debit card
Total development
Recurring costs
Operating payments
Banking RR
Committed CCN RR
OBC
Total recurring costs
In Strictest Confidence
2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10
&m £m £m £m £m £m £m &m
36.1 36.1 31.6
17.7 1.2
0.5
54.3 37.3 31.6 0.0 0.0 0.0 0.0 0.0
16.4 0.1 2.0 2.0 2.0 _ 22 23
26 0.0
19.0 0.1 2.0 2.0 2.0 21 2.2 23
Assumes write back from balance sheet to P & L relating to 2001/02 accruals
99.3 95.9 89.8 92.9 91.3 89.7 89.1 88.4
74 18.4 19.8 20.5 20.9 21.3 21.8 22.3
0.1 02 0.2 0.2 0.2 0.2 02 0.2
1.4 24 21 2) 23 24 a 24
108.2 116.7 111.9 115.7 114.5 113.4 113.2 113.0
Total
£m
103.7
18.9
0.5
123.1
29.1
31.7
736.4
152.4
18
16.1
906.6
Current Contract Costs - ex capital/bal sheet
funded
Current Contract Costs - inc capital/bal sheet
funded
127.2 116.8 113.9 117.7 116.5 115.5 115.4 115.3
181.4 1540 1455 1477 1165 1155 4184" 1155
938.
1,061.
Annex A
NPV
673.4
786.9
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: 2 iE 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Total NPV
Option 2 - Contract with new supplier £m £m £m £m £m £m £m £m £m
Capital/Balance sheet funded
Availability fees inc VAT 36.1 36.1 31.6 103.7
Capital expenditure - Banking 17.7 12 18.9
Capital expenditure - DR Cards 0.5 0.5
Total capital/balance sheet funding 54.3 37.3 31.6 0.0 0.0 0.0 0.0 0.0 123.1
Non recurring revenue/development
Banking development * 16.4 01 2.0 2.0 2.0 21 22 23 25.7
Debit card 2.6 0.0 2.6
Cost of change/migration to new supplier 0.1 04 0.5 1.0
Total development 19.0 0.2 2.4 2.5 2.0 2.1 2.2 2.3 32.7
* Assumes write back from balance sheet to P & L relating to 2001/02 accruals
Recurring costs
Operating payments - To FS 99.3 95.9 89.8 285.0
Banking RR 74 18.4 19.8 45.6
Operating payments - To New Supplier 0.0 0.0 5.9 113.8 107.5 101.1 94.8 88.5 499.9
OBC 14 vad 2.1 24 at 2.4 a Bel 16.1
Committed CCN RR 01 0.2 0.2
Total recurring costs 108.2 116.7 106.0 115.9 109.6 103.2 96.9 90.6 847.1
Current Contract Costs - ex capital/bal sheet
funded 127.2 116.9 108.4 118.4 111.6 105.3 99.7 92.9 879.8 640.8
Current Contract Costs - inc capital/bal sheet
funded 181.5 154.1 140.0 118.4 111.6 105.3 99.1 92.9 1,003.0 754.3