Select Committee on Public Accounts Minutes of Evidence


APPENDIX 1

Supplementary memorandum submitted by the Royal Mint

ARRANGEMENTS FOR THE PRINTING, LAYING AND DISTRIBUTION OF THE 2001-02 ANNUAL REPORT AND ACCOUNTS OF THE ROYAL MINT

  1.  In his opening remarks at the Committee's evidence session on 23 October 2002, the Chairman to the PAC commented: "Your report and accounts are required to be distributed to MPs but we did not get them and we received them very late. Also, they are required to be printed by the Stationery Office and that was not fulfilled".

  2.  I have now had an opportunity to investigate the Chairman's concerns in detail and thought I should write to provide the Committee with a fuller explanation.

  3.  The Royal Mint's Annual Report and Accounts for 2001-02 were laid before both Houses by the Comptroller and Auditor General on the afternoon of 15 October 2002. This was the date on which Parliament returned after the Summer Recess, and hence was the earliest opportunity for the document to be laid. In previous years, the Royal Mint's Annual Report and Accounts have been laid in July before the Summer Recess. However, the time-scales involved in the preparation of the C&AG's Report on the 2001-02 accounts meant that, exceptionally, this could not be achieved this year.

  4.  As regards the distribution of copies to members, I understand that the NAO obtained from the Royal Mint 25 copies of the Annual Report and Accounts for distribution via the Committee Clerk to PAC Members and others. I regret that, because of the interest generated by the impending PAC hearing, it appears that insufficient additional copies were made available by the Royal Mint to meet Members' immediate requirements and I offer my sincere apologies for the inconvenience that this has undoubtedly caused.

  5.  Finally, on the use of the Stationery Office for the printing of the document, I enclose for the Committee's information copies of letters exchanged between the Clerk of the Journals and the Royal Mint (not printed). Whilst it transpires that the Royal Mint had in fact complied with the requirement to use the Stationery Office, we had failed to include their publishing imprint on the title page. Again, this is an oversight for which I can only apologise and provide an assurance that this will not recur.

Gerald Sheehan

Deputy Master and Chief Executive

The Royal Mint

14 November 2002

QUESTION NO 140—CROSS SUBSIDY ISSUES

  1.  Your Committee asked that I provide a note explaining "whether there is a cross-subsidy between the British market and the overseas market". The request was made in the specific context of the Royal Mint's UK and overseas circulating coin and blank business; suggestions that the Royal Mint had been subsidising overseas euro coin production; and suggestions that the Royal Mint had been unfairly competing in the market place. This note addresses those concerns.

  2.  The Committee asked that the Comptroller and Auditor General should examine this note prior to its submission to the Committee and a copy has been passed to Sir John Bourn for that purpose.

BACKGROUND

  3.  As highlighted in paragraph 13 of the Report by the Comptroller and Auditor General (included in the Royal Mint's Annual Report for 2001-02), coin manufacture is a capital intensive industry that tends to carry a high proportion of fixed and semi-fixed costs, which vary little with customer demand. Consequently, the Royal Mint relies on order volume to achieve an acceptable unit cost structure.

  4.  In line with market demands, action was taken in 2001 to reduce plant capacity and associated operating costs through reducing shift patterns. More recently a fundamental restructuring programme has been initiated involving a significant number of redundancies (about 220).

THE CURRENT MARKET PLACE

  5.  The world market for coins and blanks is highly competitive. Quality and reliability of delivery are key factors, but cost to the customer is the determining factor in most tenders. The global industry has increased capacity, and growth in competition is noticeable from Europe, Korea and Chile.

  6.  The decision of the first wave euro countries to join the new euro currency system prompted many producers—including the Royal Mint—to increase their production capacity. Exceptionally high demand was forecast for the three-year lead up period to E-Day (1 January 2002), followed by a further one or two year period of high demand to meet the overall replacement programme. There was also the possibility that "second wave" countries might decide to join the euro currency system. Thus there was a general expectation of several years of profitable business sufficient to justify an industry-wide expansion of capacity.

  7.  By September 2001 the first wave countries (including the late entrant, Greece) forecast that overall 52 billion coins would be required for E-Day. In the event production by E-Day was close to forecasts, but demand was much lower. On 1 January 2002 only 37.6 billion coins had been issued.

  8.  There is some evidence to suggest that demand for euro coins is now increasing, but it is difficult to predict future demand patterns. However, it is clear that the peak demand has been met and that future requirements will be much lower than expected. As a result there is over capacity in the industry worldwide, and the industry is in a period of rationalisation with some companies leaving the market and others reducing their effective capacity.

RECENT TENDERS

  9.  Set out at confidential Annex l (not printed) is a summary of the invitations to tender received during the last 12 months. Where known, details of who won the tenders are provided and details about the competitor prices quoted. In many instances tender prices are not disclosed by customers and, where they are, it is often on a strictly confidential basis. The annex (not printed) demonstrates the competitive nature to the market place.

TRADING PERFORMANCE

  10.  Set out at confidential Annex 2 (not printed) are details of the Royal Mint's trading performance for the last five year period (1997-98 to 2001-02), together with details for each individual year. Euro coins were not sold prior to this period.

  11.  Contribution before direct labour is defined as sales income less those costs (metal, bought in semi-process materials, commissions, freight, packaging, utilities, wastage, and other consumables) that would have been avoided if the orders had not been taken on. However, much of the direct labour cost could not in the short term have been avoided without significant loss of production flexibility (and one-off redundancy costs). Therefore, it could be argued that these direct labour costs should be included as fixed costs. Nevertheless, "contribution after direct labour" is a prudent definition of contribution.

OVERSEAS CIRCULATING COINS AND BLANKS

  12.  As can be seen from confidential Annex 2 (not printed), the Royal Mint secured a positive contribution to its fixed operating costs from its overseas circulating coin and blank sales in each of the last five years. Overseas sales of euro coins and blanks have also shown a positive contribution in each of the last five years.

  13.  On a number of occasions competitors have quoted prices that have been much lower than that of the Royal Mint. The Royal Mint has neither followed a strategy of "unfair" pricing nor specifically targeted any competitor in the market place. There has been a need to respond to the prevailing market conditions in order to secure business and achieve a contribution to fixed operating costs.

  14.  Margins on overseas sales of circulating coins and blanks have been steadily falling due to competition and over capacity in the marketplace, but have remained positive.

  15.  The bulk of euro orders have been for copper plated blanks. The most recent euro order was for coin and thus a direct comparison can be made to UK coin prices. The price per tonne secured on this euro order was higher then the average price charged for UK copper plated coins in 2002-03, and confidential details are at Annex 3 (not printed).

  16.  The Royal Mint has obtained euro orders at price levels designed to give a reasonable contribution and has not used income from UK coin issues to cross subsidise prices for overseas euro orders. However, the Mint did encounter technical and quality difficulties in producing a number of euro orders. The resolution of these difficulties took longer than anticipated and involved considerable cost and R&D effort which reduced the actual level of contribution although it remained positive overall.

COLLECTOR COIN

  17.  Overseas and UK sales of collector coin and related items have been made at broadly similar prices in all markets and have generated significant positive contribution. The actual price charged in a particular market takes account of the relative costs associated with selling in that market and any differences in local market conditions.

TREASURY UK COIN AGREEMENT

  18.  Under the terms of its agreement with HM Treasury, the Royal Mint charges the Treasury a given price for coins issued on their behalf to the UK banks. It is not possible, therefore, to provide an exact, equivalent price for UK blanks and compare this with overseas orders. The current agreement with the Treasury is for a five-year period ending in 2005.

  19.  The Agreement is challenging. The graph at confidential Annex 4 (not printed) compares the average prices secured since 1993-94 for UK coin from HM Treasury compared to prices secured on overseas sales of coins and blanks.

  20.  The prices which can be secured on overseas orders are very volatile, but have fallen dramatically in the last two years by some 18%. On average over the last 9-year period, the prices charged to HM Treasury and secured on overseas sales have both fallen by around 30%.

STRATEGY

  21.  The production and staffing levels at which the Royal Mint has been operating over the last 18 months has meant that there has been significant capacity over and above that required for normal UK coin production. However, the Royal Mint needs to maintain a minimum capacity level sufficient to meet potential demand, which has historically been volatile and difficult to forecast.

  22.  In this situation the Royal Mint's strategy has been to secure overseas orders at sales values greater than the variable costs incurred in producing those orders. The additional contribution generated has offset the fixed costs that could not be avoided in the short to medium term. Had the additional contribution not been generated then the losses of the Royal Mint (and, therefore, the taxpayer) would have been greater.

  23.  The Royal Mint's operating profit and financial performance would have been significantly worse if it had not secured the level of overseas work that it did during this period. Indeed, in the Royal Mint's view, the overseas business is subsidising the UK business because it spreads the burden of fixed costs which would otherwise be allocated solely against UK coins.

  24.  If the Royal Mint focused solely on the production of UK circulating coin, this would require a fundamental change to its operating base. Two options could be taken:

    —  (Reduce shift patterns further and increase the cost base significantly.

    —  (Close certain plant in its entirety and reduce manpower further by approximately 40% with associated redundancy and related costs of around £18 million.

  25.  Both these options are indefensible at least in the short to medium term, and the strategy of competing for overseas business is sound. This conclusion is supported by the Royal Mint's performance in the first half of 2002-03 where an unaudited operating profit was secured. The level of profitability was in excess of the Corporate Plan forecast and the Royal Mint is currently on schedule to achieve—or better—its annual Plan target.

THE FUTURE

  26.  The planned restructuring programme and associated cost reductions will be achieved by 31 March 2003. This is designed to make the Royal Mint more competitive and profitable. It is difficult to forecast what action may be taken by competitors, and some predatory pricing is possible. However, the Mint is taking action to make further efficiencies and cost reductions in order to compete on a global scale.

CONCLUSION

  27.  Overseas orders have over the years contributed to the Royal Mint's profitability and thus reduced the burden on the Exchequer.

  28.  The Royal Mint has obtained euro orders at price levels designed to give a reasonable contribution and has not used income from UK coin issues to cross subsidise prices for overseas euro orders.

  29.  The Royal Mint has neither followed a strategy of "unfair" pricing nor specifically targeted any other competitor in the market place.

  30.  In the prevailing market conditions the Mint's aim has been to reduce capacity and costs in order to compete in a fiercely competitive international market place and to lay the foundations for sustained profitability.

  31.   I have no objection to this note being put into the public domain, but the attached annexes (not printed) are not for public disclosure because of their commercially confidential nature.

Gerald Sheehan

Chief Executive

The Royal Mint

22 January 2003


 
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