Who's footing the bill?

Gordon Brown's party conference speech last month revealed how important PFI is to the Government. Michael Cross reports on the...

Gordon Brown's party conference speech last month revealed how important PFI is to the Government. Michael Cross reports on the pitfalls and benefits of using it to fund IT projects

In a flush of early excitement over the Private Finance Initiative (PFI), an IT services firm proposed a novel way for the NHS to pay for a maternity information system. It would install the system for free, but receive a fee for every birth registered. The idea did not take off. The birth rate could not keep up with the cost of developing the system. Worse, the scheme created an incentive for maternity departments to revert to pen and paper whenever they went over budget. By the time the deal was signed, it resembled a conventional leasing contract.

Although this example seems absurd, it shows how far suppliers and politicians will go to make PFI work for IT projects. And public bodies are starting to fund IT projects using PFI even when they don't have to. Earlier this year, Norwich City Council became the first local authority to sign a PFI contract for the development of its e-government infrastructure.

Contractors BT, KPMG and Steria hope to replicate the sale. "There's no reason why it should be unique," says Mike Grundy, managing consultant, PFI and public sector at Steria.

However, the road to Norwich was a long one. In the past, several local authorities have tried, and failed, to agree PFI contracts with IT suppliers. In 2001, provisional contracts at Kent County Council and the London Borough of Croydon were abandoned after months of negotiations.

PFI contracts involving IT face three inherent difficulties:
(1) Lack of dependable revenue stream. The PFI was originally designed to pay for standalone projects such as toll bridges. "PFI relies on the construction of a stable operation that produces steady revenue streams for the service provider," says Andrew Smith of solicitors firm Nabarro Nathanson. "This is difficult in the realm of IT where technology and customer requirements can change fundamentally every few years."

(2) The cost of finance. "PFI is a challenge for the finance community as well as for IT," says Grundy. IT systems have a poor credit rating in the City, partly because in the event of failure their "step-in" value is close to zero. "A three-quarters built IT system doesn't have the same value as a three-quarters built building," says Grundy. The poor reputation of government as an IT customer does not help. All this means that banks charge a premium when funding IT projects.

(3) Negotiations can become extremely complex. On average, PFI procurements take 18 months from initial advertisement to signature. "What are the chances that your requirements are the same as when you started? None," says Smith.

The Office of Government Commerce is trying to speed up the process by issuing standard contract terms, but these may not be a complete solution. Standardisation has helped, but there's still resistance. "Both sides are cherry-picking the bits they like. Standardisation is good, but IT deals are mutating faster than anyone can write them down," Smith adds.

These factors all contribute to the central difficulty of PFI: how to allocate risk. The point of PFI is for a contractor to take on the risk of developing a service, and not be paid until the service delivers the agreed outcomes. In IT-based projects, however, outcomes may involve changes in working practices that are outside the contractor's direct control. At Norwich nearly £30m of the contract value will come from efficiency savings generated by business process engineering.

In the past, contractors have been reluctant to expose themselves to such risks. The Commons Public Accounts Committee found that BT's risk in the Defence Fixed Telecommunications System, is limited to between 20% and 50% of payment for services. At Croydon, negotiations broke down when contractor Capita felt that it was being asked to take on an unacceptable level of risk.

According to Grundy, the Norwich contract got through the process because of strong leadership. The result was a formula of risk and reward acceptable to both sides.

Steria receives a standard "unitary" payment for running IT services, plus stepped payments for each new service delivered in a change programme running over three-and-a-half years. When services, a new portal for example, are delivered and accepted, the council starts paying for them.

So is this the way forward for all public sector IT projects? Probably not. Grundy says many are simply too small. "I don't think PFI has to be considered for every contract. It still is a major effort, a long timescale - certainly a year and upwards - to put all the components in place. You have to be talking in terms of contracts £25m or more."

A surprising sceptic is the Office of Government Commerce. Its Gateway review process requires public authorities to examine every funding option, not just PFI. "There's a tendency for people to leap into PFI for everything," says Ian Glenday, Gateway programme director, "but it should be used only when appropriate."

The real test is whether PFI works. So far, the lessons are mixed. The Passport Agency's modernisation plan was a PFI failure, but another disaster, the National Probation Service Information Systems Strategy, was a conventionally-funded project. Successes, likewise, come from both camps. "Projects funded under the PFI are going wrong for the same reasons as those with conventional funding," says Smith.

He has one closing argument. On occasions where PFI-funded projects have completely failed, "at least the taxpayer has been spared some up-front cost". On that basis alone, the PFI is here to stay.

Major PFI IT contracts awarded in 2002
  • Crown Prosecution Service: 10-year deal with Logica under which the company takes over the IT systems and develops a new "e-enabled" case management system. Total value of deal more than £200m
  • Norwich City Council: 15-year, £85m contract with a consortium of Steria, BT and KPMG to manage IT and introduce e-government services
  • Driver and Vehicle Licensing Agency: 10-year contract worth £300m with PWC Consulting and Fujitsu to take over IT systems.

Ten years of the Private Finance Initiative

Conservative government launches Private Finance Initiative to fund Birmingham relief road

1995 First big IT contract funded by PFI: National Insurance Recording System for the Contributions Agency

1996 Benefits Agency and Post Office award benefits card project contract to Pathway consortium

1997 Ministry of Defence signs 10-year contract with BT to operate the Defence Fixed Telecommunications System

1999 Government cancels benefits payment card contract
Delays at the Passport Agency put government IT projects in the spotlight

2002 EDS says up-front costs in major government IT contracts are hitting profits
Chancellor Gordon Brown says the PFI is the only way to modernise Britain's public sector.

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