ICL subsidiary Pathway was chosen to modernise benefits systems and automate post offices, despite a pre-contract evaluation which showed numerous weaknesses in its bid, the report revealed.
The resulting failure of the ambitious plans to introduce a benefits payment swipe card cost the Department of Social Security (DSS) £127m in futile system development.
Sir John Bourne, head of the NAO, said more than £300m had been forgone in lost opportunities to prevent fraud while Post Office Counters had taken a £571m write-off in its accounts.
In May 1996 the DSS and Post Office Counters awarded a £1bn contract to Pathway but in May 1999 the Government scrapped the benefits payment card section of the project after continual slippage.
The NAO report shows that Pathway was chosen despite the fact that it was ranked last of the three short-listed contenders on eight of the 11 criteria used.
An evaluation team said it had little faith in Pathway's "appreciation of, and empathy with, either the purchaser's business requirements or ability to deliver a service, which would meet the required service levels".
A decisive factor in the choice of Pathway was its acceptance of greater risk - making the bid compliant with the pioneering Private Finance Initiative.
The NAO said the DSS and Post Office Counters felt they had to accept the Pathway bid or scrap the project.
The report highlighted three important reasons for the project failure:
When asked why it chose Pathway, a spokesman for Post Office Counters said that while its view had been taken into account the final decision about the contract was really made by the DSS.
A spokesperson for the department confirmed that Pathway was chosen to comply with the Private Finance Initiative.
Social security secretary Alistair Darling said, "We fully accept the NAO's conclusions on the way in which this contract was entered into. As the NAO recognises, this Government has changed the way contracts like this are entered into."
Business development director of ICL Pathway Liam Foley said he too supported the NAO recommendations and added, "Lessons had been learnt on all sides."
He added that the card system was working "extremely well" at the time of cancellation and that 37,000 people had been collecting welfare benefit for some time with it.
t The Cancellation of the Benefits Card Project, National Audit Office, HC 857
Key lessons from Pathway disaster
Procurement of Complex IT systems
Procurement by more than one purchaser
Source: National Audit Office