House of Commons - Public Accounts

Select Committee on Public Accounts Twelfth Report

THE ESTABLISHMENT OF THE JOINT VENTURE

The decision to link IT and commercialisation

5. IT impacts on practically all aspects of the Agency's work including the control and monitoring of radio usage and the allocation of radio spectrum to users. It is also a key element in the Agency's research and development work aimed at extending the usable spectrum as new technologies develop and at making greater use of the existing spectrum. By 1995 the Agency had identified the need for immediate and substantial investment in IT systems to meet users' expectations, on the basis of forecasts of continued growth in the demand for radio spectrum.[4]

6. The Agency were, however, unable to recruit and retain sufficient IT staff of suitable quality. In 1996 they estimated that almost half of the 90 or more staff they needed to support their IT activities would need to be contract staff, costing three times more than in-house IT employees.[5] The Agency wanted a solution that gave them resources to provide and develop IT systems within a relationship that was more forward-looking than was possible through the direct use of contractors.[6]

7. The Agency considered entering into an arm's length outsourcing agreement but decided that a joint venture with a private sector IT supplier would be the best option. A joint venture could give them the necessary resources at reduced cost, and could provide them with the influence they sought over the provision of IT services. In particular, a joint venture would allow their engineers, who had developed a number of IT systems, to continue modifying them in response to developments in radio spectrum technology.[7] The Agency said that outsourcing would have risked attracting bids from companies that were mainly interested in providing routine desktop services rather than the specialist services the Agency required.[8]

8. The Agency also wished to have the potential for flexibility in the delivery of IT services. The radiocommunications industry was going through a period of change and the joint venture would need to be sufficiently flexible to deal with changes in technology and economic and regulatory regimes.[9] The Agency said they would advise other public bodies to maximise flexibility in such contracts because IT is such a fast moving area. The Agency consider that their deal with CMG allows substantial re-negotiation on the basis of a long-term arrangement in which both parties' incentives are aligned.[10]

9. At the time when the Agency were considering seeking a partner for the delivery of IT services they were receiving many requests from other countries for assistance in radio spectrum management issues. They decided that there was scope to exploit commercially their expertise in overseas markets. The Agency did not, however, carry out an in-depth assessment of the market for their commercial expertise or prepare a detailed business proposal to present to potential partners.[11]

10. The Agency concluded that, as their effectiveness in radio spectrum management was dependent upon their information systems, the provider of these systems would be well placed to market them internationally. The provider would be familiar with the Agency's business and would therefore be able to market not just the information systems but also the Agency's expertise. The Agency therefore decided to include in the partnership the commercial exploitation of their systems and expertise.[12]

11. Questioned about the benefits of linking the delivery of IT services and commercial exploitation of the Agency's systems and expertise, and whether there might have been some advantage in having a separate partner for the overseas marketing operation, the Agency said that there was synergy between the two activities and they wanted to avoid a situation where two companies could be competing with each other for business. They considered that having one partner for both activities would help them build on their status as a world leader in spectrum management.[13]

The procurement process

12. The Agency initially attracted 56 expressions of interest in the project from private sector companies. From the 22 that replied to a follow up questionnaire, the Agency selected a long list of 12 potential bidders. Six of these responded to an outline specification of what the Agency wanted. Ultimately only two bids were received, one of which did not meet the Agency's requirements and was therefore rejected.[14]

13. A number of bidders and potential bidders withdrew because the Agency required the supplier of IT services to enter into a joint venture to exploit the Agency's expertise. Another factor that reduced interest was the Agency's initial proposal that they should hold a controlling interest in the joint venture company.[15] When asked why they persisted with their joint venture proposal when they saw the extent to which bidders backed away from it, the Agency said they preferred the idea of a joint venture because they were concerned to have available resources on which they could rely to provide IT systems and to develop new IT systems. The use of contractors on an individual basis had not given them a forward looking relationship and, in their view, outsourcing would not have attracted bidders capable of providing the specialist services that they needed. This remained their view despite the difficulties they encountered.[16]

14. The Agency originally envisaged that securing a partner would take 13 months. It eventually took 32 months and a number of factors contributed to the delay. Occasionally it took senior management months to approve documents. Senior management in the Agency had other priority tasks, including progressing new legislation, and the Agency had to relocate their headquarters following the destruction caused by the London Docklands bombing in February 1996.[17] Delays also arose because of disagreements about how the transaction should be implemented.[18] The Agency's then Chief Executive took responsibility for running the project with a board which included representatives from within the Agency and a number of external advisers. The Agency said they were in an experimental period, and there were a lot of discussions with other parties which took time to conduct.[19]

15. The project was run separately alongside the main work of the Agency. The Agency said that if they were doing the project again they would want the senior management of the Agency to be fully integrated into the project because it was so fundamental to the way the Agency worked.[20]

16. The Agency initially estimated that it would cost £550,000 to find a partner. In fact it cost £3.4 million. Of this approximately £2 million was paid to advisers. The Agency admitted that their initial estimates were unrealistic and they had under-estimated how difficult the procurement would be. They had learned lessons which they had applied in their budgetary control systems generally and in project management. They understood the importance of cost estimates being robust at the beginning and had since introduced rigorous controls over expenditure, the forecasting of expenditure and the allocation of expenditure to costs. They were nevertheless confident that expenditure during the project was properly monitored, by three independent members of the procurement team, and was incurred on legitimate activities associated with the procurement.[21]

Deciding on the size of the public sector's shareholding

17. In their specification for the partnership the Agency told potential bidders in April 1997 that the Agency would take the majority shareholding in the joint venture company. A subsequent review found that the company would then be classified as a public sector body subject to the normal range of Government accounting policies and requirements, which potential private sector partners did not find compatible with the pursuit of commercial enterprise. The Agency decided at a late stage that establishing the joint venture company as a public sector body would introduce delays to the procurement and decided to take a non-controlling, 30 per cent, interest in the joint venture company.[22]

18. In taking a 30 per cent holding, the Agency were trying to secure a sufficient percentage of the whole company to ensure that they had sufficient influence over what happened. They needed to have a shareholding of more than 25 per cent to ensure that CMG could not restructure the company without their consent. They wished to have less than 50 per cent to free the company from public sector restrictions, and so allow it to move fast in the marketplace and have the commercial freedom it needed for meeting the Agency's demands as customers. The Agency added that a large number of provisions in the contract gave them good control over the business even if they did not have a controlling interest.[23]

19. The Agency said that there had not been any significant financial consequences from the decision to take a 30 per cent shareholding. The profit of the company is shared in proportion to their shareholding. The profit in 1999 was £740,000 and their share was £241,000. Even if the Agency had received 50 per cent of the profits it would have been relatively small compared with the volume of business undertaken by the project.[24] When asked whether the new international business, if it took off, could realise profits which would make their share more significant, the Agency said that they might have had difficulty in persuading CMG to share profits more equally while also bearing all the downside risk of the international business.[25]

20. In relation to the decision to take a minority stake in the company had not been taken before the final specification was sent out to potential bidders, the Agency said that they had been feeling their way in a new venture. It was not clear to them that the private sector firms were reluctant to be minority partners in the company. When they decided to take a minority shareholding they notified the bidders who had withdrawn from the competition but none came back.[26]

Conclusions

21. The Agency established sufficiently flexible arrangements with their joint venture partner to enable IT systems to be developed that were not envisaged when the contract was signed. Particularly in a developing area like IT, joint venture agreements need to be sufficiently flexible to permit change in the light of new opportunities and requirements.

22. One reason why the Agency linked the delivery of IT services and the marketing of expertise in one venture was the synergy they expected between the development of new systems and their marketing internationally. This linkage did however deter a number of potential bidders, ultimately leaving only one. In seeking to interest the market in innovative business opportunities, departments should endeavour not to impose a preconceived business model that might unduly limit the scope for worthwhile proposals.

23. Delays arose during the project, some of which could have been reduced. For example, there was an initial lack of clarity about the project's objectives, and it was given insufficient priority by senior management. The Agency could also have focussed earlier on whether to seek a majority or minority shareholding.

24. The cost of securing a partnership was substantially greater than had been budgeted. The Agency had inadequate procedures for controlling, forecasting and allocating costs, though they said that these had since been improved.

4 C&AG's Report, para 1.5 Back

5 C&AG's Report, paras 1.6-1.8 Back

6 Q1 Back

7 C&AG's Report, para 1.11 Back

8 Q1 Back

9 C&AG's Report, para 1.15 Back

10 Q27 Back

11 C&AG's Report, paras 1.17, 1.20-1.21 Back

12 ibid, paras 1.17, 1.22 Back

13 Q2 Back

14 C&AG's Report, paras 2.9-2.11, 2.14-2.15 Back

15 ibid, paras 13-14; Evidence, Qs 38-39 Back