House of Commons - Culture, Media and Sport

Select Committee on Culture, Media and Sport Second Report

3 Costs

27. This section of the report addresses in turn a number of different cost areas specific to the Games: costs of staging the Games (and how those costs will be met), the cost of providing venues, security costs, VAT and contingency allowance. We conclude this section with a brief analysis of increases which have recently been identified.

Staging the games

28. Staging the games is the responsibility of the London Organising Committee of the Games (LOCOG).

How much staging will cost

29. The budget for staging the Games outlined in the Candidature File was equivalent to approximately £1.5 billion; this figure did not allow for inflation (although this is not clearly stated in the section of the bid document dealing with finances). The budget is now treated as being £2 billion - "the outturn equivalent of the £1.5 billion constant price number … submitted as part of the bid proposal" - which does take into account inflation.[56] However, no details have been supplied as to what measure of inflation has been used to arrive at the figure of £2 billion for the LOCOG budget. We encourage the Secretary of State to provide further details. There is no indication at present that costs will exceed £2 billion, and LOCOG told us that "it is absolutely our expectation to be able to contain [that budget]".[57]

30. Estimated costs of staging the Games are set out in the Candidature File. They include:

Figures in Candidature File (expressed in 2004 prices) Percentage of budget

Sports venues $417 million/£261 million 17%

Information systems $327 million/£204 million 13%

Games workforce $187 million/£117 million 8%

Ceremonies and culture $92 million/£57 million 3%

Transport $198 million/£124 million 8%

Paralympic Games $144 million/£90 million 6%

Administration $255 million/£159 million 10%

Contingency $105 million/£66 million 4%

Remaining costs $737 million/£460 million 31%

Note: Figures in $US in the second column are those given in the Candidature File; the sterling equivalents are based upon a £1 to $1.6 exchange rate as used in the Candidature File.

31. LOCOG is exempted from Corporation Tax by virtue of section 65 of the Finance Act 2006. It is, however, registered for VAT and will charge VAT on ticket and merchandise sales.[58]

Where the money for staging the Games will come from

32. The Candidature File indicated that LOCOG revenue was expected to be derived as follows:

2004 Sums Percentage of overall revenue

International Olympic Commission contribution and worldwide sponsorship $900 million/£562 million 36%

Local sponsorship $435 million/£272 million 18%

Official suppliers $290 million/£181 million 12%

Ticket sales $496 million/£310 million 20%

Licensing $92 million/£57 million 4%

Other[59] $249 million/£156 million 10%

Candidature File Table 6.6.1; Exchange rate £1 = $1.6, as used in the File

33. The contribution routed through the International Olympic Committee - forecast at 36% of the total - is substantial and depends largely on revenues from broadcasting rights and long-term funding from worldwide "TOP" sponsors[60], some of which have yet to sign up for the quadrennial covering the Vancouver Winter Games in 2010 and the London 2012 Games.[61] As Mr Deighton, the Chief Executive of LOCOG pointed out, only when the IOC contribution is confirmed will LOCOG be able to assess what its share of the worldwide sponsorship will be.[62] We note a report that the formula for calculating revenue from broadcasting to be passed from the IOC to local organising committees has changed: the report suggests that host cities will in future received a fixed sum rising in line with inflation rather than a proportion of the revenues from broadcasting rights.[63] If confirmed, this arrangement may be to the disadvantage of both the London and Vancouver Organising Committees; and we may wish to return to this.

34. 30% of LOCOG revenue is to be raised through local sponsorship and official suppliers. The distinction between these two sources in the bid document reflected the difference between cash benefit and benefit in kind. Tenders are being invited for domestic sponsorship in six industrial sectors: banking, insurance, telecoms, automotive, utilities, and oil and gas.[64]

35. The £2 billion target was described by Business in Sport and Leisure, representing the private sector sport and leisure industry, as "challenging";[65] but LOCOG is optimistic about its chances of raising the sum required, assuring us that it is "confident at this stage [that] the sources of revenue available to us are sufficient to leave us … with revenues that will match our expenditure".[66] When asked how he would proceed if revenue fell short, Mr Deighton rejected two alternatives put to him, one being to trim the expenditure to the revenue raised and possibly provide a lower-quality experience, the other being an appeal for taxpayer funding.[67] He did indicate, however, that if LOCOG's costs were to rise beyond £2 billion and if LOCOG was unable to raise further private financing to support those extra costs, it would be "a matter of choosing priorities amongst the things that we are trying to do on the staging side".[68]

36. The Secretary of State told us that LOCOG had reason to be confident and she did not envisage providing emergency funding to LOCOG. She was careful, however, not to rule out such a course of action.[69]

37. We note in this context the experience of the Sydney Organising Committee (SOCOG), which fell short of its target for revenue. The New South Wales Government had undertaken to underwrite the cost of the Games, and the Legislative Council duly agreed an emergency bill to authorise Aus $140 million contingency grant to SOCOG in June 2000, only weeks before the start of the Games. The General Purpose Standing Committee No. 1 of the New South Wales Parliament found that SOCOG had not only suffered from a shortfall in sponsorship revenue but had also overestimated revenue from ticket sales.[70]

38. On 17 November 2006, Ofcom announced its intention to introduce a total ban on the television advertising of all foods high in fat, salt and sugar in and around programmes of particular appeal to children under the age of 16.[71] A period of consultation will be held before a final decision in January 2007. The Government has welcomed the announcement.[72] It is unclear yet whether there will be an impact on amounts which sponsors will be willing to contribute to the Games. The Chief Executive of LOCOG pointed out that food, restaurant and drinks sponsors were already committed through the worldwide programme negotiated with the International Olympic Committee;[73] and the Secretary of State (when giving evidence after Ofcom had made the announcement) said that she understood that, at this stage, LOCOG did not believe that it would have to adjust sponsorship estimates in the light of the announcement.[74] However, we recommend that further work be done to determine the potential impact of the ban and whether it will have an effect on sponsorship for the Games.

39. We admire the confidence of the LOCOG team in its capacity to secure the necessary revenue, including sponsorship. It would be wrong, however, to ignore the fact that amounts raised through sponsorship and licensing, as well as from ticket sales, are hard to predict and may turn out to be lower than foreseen in the Candidature File. While exchange rate sensitivities may have little effect on LOCOG's costs, they may have an impact on revenue contributions from the International Olympic Committee, which will be denominated either in US dollars or in a mix of US dollars and euros. We note that LOCOG has already put in place a mitigation strategy and has entered negotiations with a UK bank to hedge the risk.[75] We believe that LOCOG and the Government should recognise the possibility that revenue may fall short of that forecast; and we believe that they should give early consideration to the implications.

40. Business in Sport and Leisure told us that the drive for sponsorship for the 2012 Games would place a strain on the sporting sponsorship market, "especially given the lure of the heavily attractive Olympic marks". There was a potential consequence, it warned, of a loss of revenue to grassroots and community sport; and it was not convinced that that impact had been fully assessed.[76] The Institute of Professional Sport - a national association for professional players - also believes that the business sector "will be challenged" and that "cuts in sponsorship programmes at community level may be experienced".[77] Mr Deighton, Chief Executive of LOCOG, doubted that there would be a significant adverse impact, arguing that companies generally treated Olympic sponsorship as "a rather separate event because of its breadth" and that sponsorship funding would be drawn from a marketing budget rather than out of a sport sponsorship budget.[78] The Secretary of State was rather more cautious, telling us that the issue was being looked at "very carefully".[79] The optimism of LOCOG that the effort to secure sponsorship for the 2012 Games will not detract from sponsorship for community sport is welcome. However, the Committee will keep this under review.

Venues

41. The cost of permanent works for each of the main sporting venues will be borne by the ODA. The table below sets out both the estimate of costs in the Candidature File[80] for each permanent venue, in 2004 prices:

Estimated cost, 2004 prices

Olympic Stadium $450 million/£281 million

Aquatics Centre $117 million/£73 million

Hockey Centre $23 million/£14.3 million

Velodrome $46 million/£28 million

Permanent arena $42 million/£26 million

International Broadcast Centre/Main Press Centre $215 million/£134 million

42. In August 2005, the ODA appointed the CLM Consortium as Delivery Partner, "to programme and manage the whole procurement and construction cycle, from design to post-2012 transformation".[81]The role of the Delivery Partner has since evolved, an issue which we discuss later, at paragraph 58 of the report.

43. The Secretary of State told us that there had been no increases in the cost of venues since July 2005;[82] and she drew our attention in July 2006 to her requirement that the proposed design for the Aquatics Centre be reconsidered "in the light of what appeared to be increased costs".[83] She said however that, given that the project was currently out to tender, she would prefer not to give us a specific figure for the estimated cost of the Olympic Stadium.[84] When announcing to the Committee on 21 November 2006 that £900 million of extra costs had been identified, she cited rises in commodity prices and revised figures for construction inflation as factors contributing to those extra costs.[85] It seems likely that such factors will affect the costs of constructing venues.

44. In addition, the contribution from private sector funding to the cost of construction of venues, which was anticipated in written evidence from LOCOG to the Committee in September 2005,[86] may turn out to be lower than had been hoped. The Secretary of State told us in November 2006 that "further costs arise specifically from the need to secure greater public funding for the Olympic Village and the International Broadcast Centre", the amount of those extra costs being "subject to commercial negotiation about what the level of private sector investment will ultimately be".[87] She provided further detail in a subsequent letter to the Committee Chairman, explaining that the private sector is expected to provide "the majority of the financing" for development of the Olympic Village, which it was hoped would make a commercial return after the Games; and she stated that a mix of public and private financing was envisaged for the International Broadcast Centre and Main Press Centre. No private financing was expected for the construction of sporting venues.[88]

Security

45. The total security cost identified at the time that the bid was submitted was £213 million: approximately £23 million for in-Games security[89] (to be borne on the LOCOG budget) and approximately £190 million in site security costs, to be borne by the ODA from the public sector funding package. These figures pre-date the bombings of 7 July 2005. Further expenditure will be incurred in relation to wider security in London. These costs will be borne by the Home Office and the Metropolitan Police and are still under review.[90]

46. The Secretary of State stated unequivocally that the existing security budget was "inadequate", but she gave no further indication of the order of any increase.[91] Some detail of additional costs emerged during the appearance by the Mayor of London before the London Assembly on 15 November, when he indicated that there might be a further £300 million "opportunity cost" and "maybe another £250 million" for measures such as electronic monitoring".[92] We urge the Secretary of State to publish the revised budget for security costs, as soon as it has been agreed.

47. Mr Deighton told us that overall responsibility for security at the Games rested with the Home Office and the police.[93]We find it strange, therefore, that no responsibility for security is attributed to the Government in the detailed breakdown of Objectives by Lead Stakeholder approved by the Olympic Board.[94] The lack of any reference in the Olympic Objectives to the Government having responsibility for security at the Games appears to be an oversight which should be rectified.

VAT

48. At the time that the Committee took evidence for this inquiry there appeared to be a strong possibility that the ODA would be liable to pay VAT on goods and services which it procures. That liability has since been confirmed.[95] One estimate of the total payable is £250 million, although higher figures have been suggested.[96] The Secretary of State told the House that VAT had not been included in the original bid because, at that time, "the position of the unspecified delivery body, which had not been legislated for or given effect, could not be anticipated".[97] She added that the VAT issue "was not raised by PriceWaterhouseCoopers, who advised us on the costs, nor were issues in relation to VAT at that point identified by the Treasury or by departmental accounting officers". In evidence to the Committee, she said that there were certain bodies - including local authorities and the Environment Agency - which do not pay VAT; and she cited several precedents from previous Olympic Games where either VAT had not been paid or a concession had been secured.[98] It appears that an assumption was therefore made that the future ODA would be similarly exempt. The Secretary of State told us in oral evidence that it was made clear in the Candidature File that the bid was submitted net of the cost of VAT;[99] but, when pressed to indicate where exactly in the bid document such a statement was made, she did not provide any reference.[100]

49. The Chancellor, in an interview on the Today programme on BBC Radio 4 on 7 November, said that "when we did the original application, there was one form of company organisation that might not have required VAT; now that we have looked at the thing in detail, there may be another form of company organisation for the Olympic deal".[101] He added that "even if VAT is payable, it's not an issue for us - it's money that is transferred from the Exchequer, or to the Exchequer; it's not an issue about the overall bill in the end as far as how the taxpayer has got to pay it". The Secretary of State confirmed to us that there would not be a cost to the taxpayer, describing it as "much more of an administrative matter rather than it is a substantive funding matter",[102] and the Chief Executive of the ODA described the issue to the London Assembly on 15 November as a "technicality" which "can be solved by a technical adjustment to one of the Finance Bills".[103] We welcome the assurances by the Government that the ODA's liability to pay VAT on goods and services will have no impact on the taxpayer. We note that the matter is now under discussion between DCMS and the Treasury, and a decision is to be made "soon".[104]

50. The Committee regards it as unsatisfactory that this issue has emerged so late in the process and that it was not resolved at the time of the preparation of the bid document. The Secretary of State maintained that there had not been an oversight and that an "initial judgment" had been made, informed by precedents from previous Games.[105] However, this has clearly proved to be wrong. We are surprised that the Treasury did not establish the position from the start. The Chancellor now needs to provide an explanation of how this arose, particularly given that VAT did not have to be paid on the costs of the Athens Games. He also needs to provide details of how this issue will be resolved as soon as possible, in order to ensure that there is no adverse impact on the financing of the Games. There may also be a requirement to agree any solution with the European Commission, which could result in further delay.

Contingency

51. No final decision has been taken on the size of contingency which should be allowed for the Games. The bid document gave a contingency figure for LOCOG of 4% of its total expenditure, namely $105 million at 2004 prices;[106] this would translate to £87 million from its overall budget, allowing for inflation and the £1 to $1.6 exchange rate used in the Candidature File. The contingency allowed for projects funded from the Public Sector Funding Package - principally construction projects - was calculated individually and ranged from 20% to 23% for each.[107]

52. Discussion now centres on whether a "programme contingency" should be applied on top of the various project contingencies already allowed for, and what the size of that contingency might be. The Secretary of State told us that programme contingency had not been part of the original advice in drawing up the original bid, but she believed that there was "broad consensus" now that it was necessary (and she confirmed that she was part of that consensus);[108] and she added that that view was supported by KMPG, who had advised DCMS on reviewing the costs of the Games project. [109]

53. The question of what level of contingency would be appropriate is disputed. The Mayor of London has stated on the Today programme on BBC Radio 4[110] that 20% should be the maximum figure for programme contingency, although he indicated to the London Assembly that the Olympic Delivery Authority favoured 30%.[111] The Treasury has produced guidance, in the form of supplements to the Green Book,[112] on adjustments which should be made to estimates of a project's costs, benefits and duration to allow for "optimism bias" (defined as "a demonstrated, systematic tendency for project appraisers to be overly optimistic"). That Treasury guidance, which draws on advice provided by consultants,[113] proposes adjustment percentages for different types of project, ranging from single-figure percentages for low-level capital expenditure projects to 51% for "non-standard building" projects and 66% for "non-standard civil engineering" projects. Footnotes in the guidance point out that these are indicative starting values.

54. The Management Statement and Financial Memorandum which governs the ODA instructs it to comply with Green Book requirements.[114] Depending on how the Olympic project is categorised, what the final cost is, and whether Treasury guidance is adhered to rigidly, the programme contingency could approach £2 billion. The Mayor of London has publicly expressed reservations about the principle of announcing a contingency, believing that to do so encourages overspend; and the Secretary of State told us that "the Mayor is absolutely right that we will take every available step to avoid and prevent a contingency being translated into a cost".[115] The Mayor has also acknowledged that he is in direct disagreement with the percentage figure proposed by the Treasury, saying that "there are no circumstances under which I'd agree to a contingency of that size".[116] The Secretary of State has made it clear, however, that the final decision on the level of contingency is a matter for the Government.[117]

55. The Committee questions the rationale for allowing for programme contingency on top of project contingency, especially at a percentage as high as that proposed in Treasury guidance. We find it difficult to see how a programme contingency of any substance, rather than simply being prudent, does not run the risk in itself of escalating the costs. We note that programme contingency was not included in advice to those responsible for co-ordinating the bid but that there is now an informed consensus that it should be included. This new issue of additional 'programme contingency' gives the impression, rightly or wrongly, that the initial advice upon which DCMS relied appears to have been deficient; and we believe that the Treasury could and should have drawn attention to this alleged deficiency before the bid was submitted. Given the possible scale of such a new provision, the rationale for 'programme contingency' should be thoroughly explained, with practical reference to other major building projects around the world, and the professional advice to the Treasury and DCMS (including that of KPMG) to justify this should be published for the benefit of public understanding.

Cost increases: the £900 million identified so far

56. The Secretary of State instituted a fundamental review of the costs of the Games immediately after London had been selected as Host City; and KPMG consultants were engaged in October 2005 to support that review.[118] KPMG's role was "to re-assess costs to ensure that there is a sound cost baseline and to help identify the scope for savings in potential costs with a view to keeping costs down".[119] That work is largely complete, although the overall cost review is continuing.[120] The Secretary of State said that the re-assessment had confirmed that whereas core cost estimates of the venues were unchanged, increases in core expenditure were to be anticipated in other areas.[121]

57. There is now a concentrated effort within Government to quantify the real costs of the Games and to set a budget for the ODA. That work is expected to conclude "soon" and the Secretary of State has undertaken to report to Parliament on the findings.[122] The review has already identified £900 million of extra costs which relate exclusively to the Olympic Park and which bring the Public Sector Funding Package from the £2.375 billion agreed at the time of the bid up to £3.3 billion. This £900 million increase takes into account increases in commodity prices as well as adjustments to transport figures "so that they reflect 2012 prices" and a revised estimate for construction inflation.[123] We have since noted an indication by the Secretary of State that "the additional cost of the site security of the Olympic Park … was included in the £900 million increase … announced to the Select Committee on 21 November 2006".[124]

58. The £900 million increase also reflects the cost of cost control itself. In August 2006, the ODA appointed the CLM Consortium as Delivery Partner to "programme and project manage the whole procurement construction cycle, from design to post-2012 transformation".[125] The Secretary of State told us that the ODA, when established, had concluded that further expenditure was needed "to provide the level and quantity of expertise and skill necessary to deliver … the project … and to undertake effective project and programme management and cost control".[126] A further £400 million is therefore being invested "in order to secure the services of the delivery partner" and also to cover "costs of site mobilisation and the costs of additional staff required by the ODA itself".[127] A substantial extra sum, not provided for in the initial bid, is to be paid to the Delivery Partner to provide effective management and cost control. We welcome the determination to ensure proper delivery of the 2012 London Olympics. However, we are surprised that, given the original assurances about the rigour of the budgeting process, it is only now seen to be necessary to include this additional element of control and that it is such a significant cost. We can only conclude that cost control procedures were not fully thought through at the time that the bid was submitted. We call upon the Government to provide a detailed explanation of how the figure of £400 million for the Delivery Partner was arrived at, including any total cost of construction which has been used in arriving at this fee. We further call for the main terms of the agreement with the Delivery Partner to be made public.

59. The £900 million increase already announced is not the final say: the Secretary of State added that "there are also further funding requirements not yet translated into firm costs which are a matter for discussion in Government".[128] These further funding requirements include costs of security, contingency and tax liability, each of which we have discussed above. Clarification of these further funding requirements is essential when the Secretary of State reports to Parliament, as promised, on the findings of the cost review in train. The Secretary of State also undertook to disclose as much information as possible to the Committee and to return at any time to brief us further on costings.[129] We welcome the Secretary of State's readiness to provide as much information as possible to the Committee. We recommend that, given recent controversy about the cost of the Games, the Secretary of State's report to Parliament on the conclusions of the cost review currently under way is as comprehensive as possible and should be in the form of an Oral Statement.

60. We note the statement made by the Secretary of State to the Committee in October 2005 that "I can confirm again the rigour which we are applying to the costs in order that they are contained within that expenditure limit" [£2.375 billion].[130] Similar statements were made later in 2005.[131] The Committee is disturbed that such statements have been disproved in such a relatively short space of time. It is particularly ironic that part of the extra costs already identified will be incurred in paying a delivery partner to exercise cost control.

61. The Committee is concerned about the distance between the figures submitted in the bid and the true costs, which will not become evident until after the Games. We believe that everyone involved should draw lessons from this in terms of project appraisal, management and communication at this relatively early stage so that there is no repetition which would prejudice public support for the Games, their success or their legacy.

62. The Accounting Officer for the Government Olympic Executive (essentially the unit within DCMS which is responsible for developing policy on the 2012 Games) outlined a number of budgetary control procedures used in relation to the Games. The Olympic Board itself, comprising the Secretary of State at DCMS, the Mayor of London, the Chair of the British Olympic Association and the Chair of LOCOG, is responsible for approving and analysing the ODA and LOCOG budgets before they are set. The Olympic Programme Support Unit, an independent body of secondees from stakeholders which provides secretariat and monitoring functions for the Olympic Board,[132] provides a monthly analysis of progress in expenditure and delivery; and Treasury consent is required for ODA projects costing more than £20 million.[133]

63. Importantly, in our view, there is external scrutiny. The Office of Government Commerce (OGC) provides continuing oversight on risk within the project;[134] and the Secretary of State confirmed to us that the National Audit Office will have a particular role in relation to value for money, possibly including examination of the process used to generate financial estimates.[135] We stress the value of external assessment in building public confidence that money is being spent properly, and we particularly welcome the involvement of the National Audit Office.

56 Q 6; also DCMS memorandum para 3.5, Ev 56 Back

57 Q 6 Back

58 Candidature File, section 6.5.3 Back

59 Includes national government subsidies, disposal of assets and other sources Back

60 TOP - The Olympic Partners programme Back

61 Q 17 Back

62 Q 17 Back

63 Daily Telegraph, "2012 funding alliance", 9 November 2006 Back

64 The first invitations were announced for firms in the banking and insurance sectors in October 2006: See London 2012 Media Release, 28 September 2006. Back

65 Ev 35 Back

66 Q 20 Back

67 Q 17 Back