The New Contracting Approach
The Private Finance Initiative and IT have always been rather uneasy bedfellows. In the mid-1990s the IT industry and many public sector organisations were unwilling to embrace the Treasury Taskforce mandate that the PFI should be used for major IT projects. Since then, IT has been seen as being a problem area for PFI. Projects such as Inland Revenue NIRS2, the Passport Agency project and, more recently, the LIBRA project for the Magistrates Courts have all got into difficulties.
The extent to which these failing projects really adhered to PFI principles is open to question. Very few major IT projects have been structured on PFI principles as they are generally understood in other market sectors. None of the projects referred to above had project-specific third party funding or were contracted through a free-standing special purpose vehicle. Throughout the period, IT contracts have tended to remain awarded to fully-funded IT-sector prime contractors.
The perception that IT projects and PFI do not mix resulted in HM Treasury announcing in “PFI: Meeting the Investment Challenge” last July that PFI in the IT sector would be replaced by a set of procurement options appropriate for different types of IT projects. The announcement was a radical about-turn as HM Treasury stipulated that the PFI should not even be available as one of the portfolio of options available for use for IT projects.
The Office of Government Commerce was then given the responsibility of producing Guidance on contracting for IT projects. Draft Guidance was issued for consultation in December 2004. The consultation period has now ended and OGC is intending to finalise the Guidance in Autumn 2004.
The Guidance is not intended to be mandatory. However, compliance with certain aspects of the Guidance will be on the agenda for Gateway reviewers. This means that Departments will need to have good reasons for not following these aspects of the Guidance, in order to avoid a negative Gateway review report.
The Guidance contains two sections: a Decision Map which is for use when deciding the appropriate contracting mechanism for an IT project, and Guidance on IT Contracting which deals with specific IT contractual issues. OGC intends to issue contract terms to cover the key aspects of IT contracting. These were not issued in December 2003, except wording dealing with intellectual property rights and change control procedures.
Decision Map for IT Procurements
The new Decision Map approach is intended to help public sector IT customers to choose the most appropriate contract structure for an IT project. More specifically, it tries to help customers “think through the linkage between departmental goals” and the intended “outcome, output(s) and input(s)”, together with the “key risks”.
The Decision Map retains the PFI mantra that “risks should be allocated to the party best able to manage them” in order to assess whether a contract should be for “outcomes, outputs or inputs”. It is not clear why the Guidance uses this relatively unfamiliar terminology: in general terms the Guidance appears to envisage that “outcomes” projects are business process outsourcings and are appropriate where “there is confidence about the long-term goals, stability of the organisation and business objectives, and the outcome responsibility can be passed to a contractor”. Outputs projects relate to the provision of IT goods and services, and include the transfer of production risk to the contractor. The Guidance recognises that outputs are difficult to define but that if properly defined an outputs project can “deliver step-change improvement”. The Guidance recommends that contracts for inputs should only be used where the customer has the ability to integrate a variety of contracts for inputs to deliver the output.
One of HM Treasury’s key themes for IT projects is that for IT projects smaller is better and less risky. OGC identifies particular concerns where projects are innovative. It recommends that short, small contracts are more likely to have a chance of success and that contracting for inputs is likely to be more appropriate. OGC also recognises that customer skills and capabilities are a major factor in ensuring project success and that if a customer does not have commercial and contract management skills then short, small contracts will be less risky.
Once a public sector customer has decided that an IT project is best served by an outcomes, outputs or inputs contract, the intention is that a number of “deal shapes” will be developed which will identify the appropriate contracting arrangements for the particular type of contract. The sections dealing with the “deal shapes” are relatively undeveloped in the draft Guidance. This may be as a result of the relatively abstract approach to IT contracting that OGC has chosen to adopt. It is not easy to develop concrete deal profiles for the more common IT contracting situations (such as approaches to software licensing and support, application development and integration, and business processing and IT outsourcing) within the context of contracts for “outcomes, outputs and inputs”. The Guidance may have been more helpful if it had taken a less theoretical approach.
The later parts of the draft Guidance deal with strategic contracting issues, tactical contracting issues and a series of “deal shapes”. The key strategic contracting issues include:
- Maintaining competition: emphasis is placed on the need to maintain a competitive environment both during the contract and at the end of the contract for the re-competition. Customers are advised to look at the issue of single or multiple suppliers, length of contract, definition of requirements, termination and ownership of any project assets.
- Single or multiple suppliers: the guidance looks at when and how an authority might contract with one supplier or a number of suppliers. Multiple suppliers may be relevant where separate contracts can be awarded for different components of a project, or where separate contracts can be awarded for different geographical areas.
- Proof of concept: customers should consider whether a proof of concept stage should be used to enable bidders to carry out a limited development exercise as part of the procurement.
- Change and control flexibility: authorities are advised to agree as much as possible pre-contract award and to ensure that a robust change procedure is put in place.
- Ownership of assets: the guidance sets out the considerations to be borne in mind when deciding whether the authority or the service provider should own the assets or if the authority should lease the assets. Similarly, guidance is given on the ownership and licensing of intellectual property rights.
The section of tactical contracting issues contains some of the most significant aspects of the Guidance, dealing with:
Integration issues: the complex issues of integration at the programme, business and technical levels are dealt with. Importantly, the Guidance recommends that authorities should start developing and addressing the people and process issues associated with integration right from the commencement of a procurement process. All too often, integration is dealt with as a “bolt on” concern once the project issues have been dealt with.
The role of prototypes and pilots: the Guidance encourages the use of prototyping and pilots, particularly where there is uncertainty about an implementation approach or where there is a need for a proof of concept during a procurement process. The Guidance deals with IP ownership issues and payments issues. It also clarifies the relationship between pilots and the normal test periods which should be included in all IT delivery contracts.
Payment Structures: the guidance on payment mechanisms is of particularly interest to the supplier community and the section appears to have been the outcome of a somewhat uneasy compromise between OGC’s project delivery concerns and financial probity issues. The position on milestone payments is a good example. The Guidance initially sets out a financial probity approach in saying that milestones payments should not be used but then outlines a very extensive list of exceptional circumstances where milestones are possible. These “exceptional” circumstances in fact cover most of the circumstances of IT delivery and development projects.
Technology refresh: whilst the Guidance is to be welcomed in that it recognises that there is a need for authorities to provide a financial inducement to carry out technology refresh, the Guidance could go further in recognising that making payments specifically for technology refresh will be more likely to make the refresh occur.
Service credits and liquidated damages: guidance is provided of a relatively conventional nature on a number of service credit issues, such as “caps” on service credits and whether a service credit “holiday” should be provided on initial service implementation. The guidance is rather more novel in its coverage of “earn-back” mechanisms which have not been used to a great extent in public sector IT contracts. The intention of these “earn-back” mechanisms is to incentivise contractors to develop and implement service improvement plans in order rectify service level problems. In certain, circumstances this mechanism can be a useful mechanism for public sector authorities to have available where a contractor is prepared to accept on-going service level defaults.
Usefulness of the Guidance
The guidance is a useful collection of points for consideration, issues and risks. It rarely mandates a particular approach, but rather sets out the relevant points for consideration. In summary, this guidance will be of help to those experienced in IT procurement, since it lists the relevant considerations but does not force a procurement down a particular route. It does not provide answers to all the issues on IT procurements, but it does identify a number of the key issues and sets out sensible discussion of them and possible ways of handling them.
The set of guidance is incomplete: some new model drafting on terms and conditions is expected over the next few months. There is some controversy in the industry over whether OGC will follow the approach taken by the Department of Health in its National IT Programme. The IT Industry has significant problems with the Department of Health approach and there are particular concerns that they could act as a disincentive to bid for public sector projects for small and medium size enterprises.
First published in the June/July 2004 issue of PFI Intelligence Bulletin.