We have some concerns about the price adjustments and value for money challenges

3.15  Whilst the procedures to monitor prices and the value for money challenge mechanism are to be welcomed in principle, we have some concerns about the price adjustment formulae and the effectiveness of the value for money challenge terms. If the price indices in the Variation of Prices formulae move as expected, the arrangements favour BT as they are likely to receive upwards price adjustments faster than the Department will receive the benefit of falling telecommunication prices. Prices for the non-telecommunications services, whose costs contain a larger proportion of elements which are likely to increase in price, such as labour, are subject to quarterly adjustments. Prices for telecommunications services, however, which are expected to fall as a result of being more closely linked to changes in the telecommunications market are adjusted annually. The annual adjustments take place in July, and are based on the April prices, so a reduction in telecommunications prices may not feed through into the Department's tariffs until up to fifteen months after it occurs. It is not possible to compare the impact on prices of receiving annual against quarterly adjustments, as this will depend on the extent to which BT's initial tariffs took account of the adjustment mechanism.

3.16  In July 1998, following the first full year of the contract, there was an overall weighted average price increase of two per cent (equivalent to a fall of 0.7 per cent in real terms). In the second year of the contract there was a further reduction in the average price of telecommunications elements of just under 1.7 per cent11. Figure 14 shows the ranges of price movements for the telecommunications services, and the overall weighted averages for the first two years of the contract.

3.17  Our legal consultants consider that the value for money challenge provisions are not drafted clearly enough to be relied upon by the Department in the event of a dispute with BT. The effectiveness of the price challenge mechanism may be limited because the contract only allows it to be used in exceptional circumstances, without defining what these are. Although the challenge is to allow a value for money review to be undertaken, the contract does not indicate how value for money is to be measured. The condition that the circumstances should be exceptional may allow BT to resist the use of the value for money challenge mechanism. Where it is used, the absence of guidance on how value for money should be measured (for example by reference to similar services provided by other suppliers) could result in disputes if the parties fail to agree on how the value for money review is to be carried out. The Department feel that greater detail in the contract would have been too restrictive and would have resulted in legal difficulties in the event of a challenge. There are also practical disincentives to mounting such a challenge, as it would take time to effect and the Department . would need to be very certain of their case before attempting this. BT will have taken account of these challenge provisions when pricing their contract. This will only be good value for money if BT have a genuine concern that a challenge may be made.

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11  This average figure is weighted for spend for each telecommunications service. The telecommunications services exclude the BOXER and UNITER support services