Revenue expects to escape challenge over illegal deal

The National Audit Office's report into the outsourcing deal for UK National Insurance payments pulls just about all its punches,...

The National Audit Office's report into the outsourcing deal for UK National Insurance payments pulls just about all its punches, reports Tony Collins

Phil Morris, an expert in the contracting out of computer services, believes the latest IT report from public spending watchdog the National Audit Office (NAO) is particularly interesting, but not for anything it contains.

"The report is very gently worded," said Morris, director of sourcing specialist Morgan Chambers. "And it is interesting because of what it doesn't say."

The report in question is the NAO analysis of Inland Revenue's decision to award, without open competition, up to £144m-worth of additional work to US-based IT services supplier Andersen Consulting, now Accenture. The work relates to a system that handles all the national insurance payments for the UK population.

Enhancements to Accenture's National Insurance Recording System (Nirs2) were needed to support legislative changes including the introduction of stakeholder pensions and pension sharing on divorce.

The study by the NAO was into what it called a "contract extension" to Accenture's original deal with the Government signed in 1995.

Under the original Private Finance Initiative (PFI) deal, Accenture replaced the old Nirs1 system - based on ICL mainframes running the VME operating system - with new purpose-built software running on Hewlett-Packard servers at Warwick.

At a cost of £45m, the Nirs2 contract seemed such a good deal for taxpayers that the NAO reported in May 1997 that it represented "strikingly good value for money". Accenture's £45m price tag was nearly one third of the bid of its nearest competitor, CSC.

However the latest NAO report on the contract extension, published last week, highlights weaknesses in the original contract.

Critics of the deal point out that, from an IT supplier's perspective an ideal outsourcing contract has the customer locked into a service with no practicable means of going elsewhere for major enhancements to the system, and no pre-set low prices for such major changes.

The Nirs2 deal was beginning to look like such a contract.

When the Government changed pensions legislation in 1998, the Inland Revenue discovered that the only practicable means of delivering support for the new legislation was by way of major changes to Nirs2.

But there was no simple means of agreeing a cost with Accenture. The original PFI contract had no defined mechanism for making unexpected major changes to Nirs2, other than by means of the standard framework rates agreed between the Government and IT suppliers. These rates were "considerably higher" than those originally agreed with Accenture on the Nirs2 contract, said the NAO.

Buying from another supplier was not a feasible option, partly because Accenture controlled most of the system skills, it operated the contract to manage the project, and it owned the copyright in Nirs2's software.

There were other deterrents to bringing in an alternative supplier to tackle the extra work. The original contract prevented anyone else making major changes to the system unless the Revenue exercised a break clause in Accenture's contract and put the work out to open competition.

The cost of terminating the contract early, plus a new supplier's transitional costs, would have added a further £44m to the cost of the system changes. And a new competition could have delayed the Government's legislative programme, said the NAO.

Accenture was, at least, a quantifiable risk: it was commercially stable, it had the support of business end-users and its problem-solving on Nirs2 had been exemplary.

Ultimately the Inland Revenue was faced with three difficult choices, all of which offered little leverage:

  • Negotiate an extension to the original contract on terms acceptable to Accenture
  • Buy the major changes at high framework rates from Accenture
  • Exercise a break clause and risk delaying the introduction of IT support for new legislation

So last year the Revenue decided to award Accenture a "contract extension", without any open competition, giving the company up to £144m of extra business - a 300% increase in the value of the original contract.

There was a big incentive to sign a new deal with Accenture: the supplier had agreed to terms that addressed many of the weaknesses in the original contract. However, the extension broke European directives on open competitive tendering which are incorporated into UK law.

Under European law, if a contract is altered substantially, it must be re-tendered; and in this case the contract was changed fundamentally.

Under the original PFI deal, Accenture would receive payment only when the system went live. Under the terms of the extension, however, Accenture will receive payment, in stages, for development before the system as a whole could be seen working.

The Revenue's lawyers advised that, in view of the change in the way payments were made, the contract extension might not be legal. But they said there was a minimal risk of any court challenge.

Finally Inland Revenue "decided that the costs of delaying the work programme and the advantages of the revised arrangements outweighed the risks associated with failing to comply with the procurement rules," said the NAO.

No disapproval of the Revenue's decision to break the law was indicated in the NAO report. Nor did the report make any direct criticism of, or identify, the officials who advised ministers to sign the original contract.

Morris said the Nirs2 report highlights a problem with the accounting to Parliament of problems on some major deals involving the contracting out of IT services.

Much of the detail is in the NAO report but, he says, there is "no context for what amounts to a series of factual statements".

He believes that the diplomatic wording of the report makes it clear that the text has been re-drafted to make it acceptable to the Inland Revenue (all NAO reports must be agreed by the departments before being published).

For example, in the latest Nirs2 report, many of the negative findings are mitigated or subsumed into positive statements. Indeed a formal notice summarising the Nirs2 report opens with statements that the contract extension supported major legislative changes, offered better value for money than the alternatives, delivered the required enhancements on time and improved the way development work is managed and paid for.

"It appears to me to be a sanitised report," said Morris. "The statements about the problems do not build up to any critical conclusion."

What the report does not do is give any insight into the legal advice or procedures that allowed fundamental weaknesses in the original contract to escape detection. For example, it does not explain why the Government came to be locked into a deal with Accenture, or how ministers came to be advised that they could go ahead with legislation while the implications for the systems were not understood.

Nor does it draw attention to the fact that a £45m PFI deal, in which the supplier receives no payment until a system is online, has been turned into a much bigger contract under the 1980s-style "cost-plus" arrangement with the supplier whereby it receives its costs plus an agreed share of profit.

And there is no attempt to emphasise the importance of learning from the mistakes by pointing out that similar errors have occurred on other major PFI projects involving IT and out-sourcing.

The report will, however, form the basis of a hearing of the House of Commons Public Account Committee on 3 December, when more searching questions may be asked.

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