3.34 Under the original contract, BT received Department assets for a nominal charge of £1. If BT fail to win the next contract the new supplier will similarly only pay BT £1 for any of these assets which remain at the end of the contract period, and which the new supplier needs to deliver the service. It is unlikely, however, that many of these assets will remain at the end of the period as BT are expected to undertake extensive investment and modernisation of equipment.
3.35 BT will receive payments from a new supplier, known as transfer payments, for assets and equipment which have been introduced by BT and which the new supplier chooses to use. Although a new supplier will select which, if any, service's assets they wish to purchase, if they do choose to use some of the existing assets for a particular service, they must buy all the assets for that service. The transfer payments for assets and equipment introduced by BT will be based on specified percentages of the annual charge for the relevant service in the ninth year of the contract. Based on estimates of spending in 1999/2000, transfer payments for all assets and equipment for all telecommunications services would be £43 million, some 30 per cent of the total annual spend on the contract.
3.36 Whether this form of transfer payment arrangement will produce value for money is finely balanced. There was no Treasury guidance on transfer payments when the Department let this contract but in their 1999 guidance on contract terms, the Treasury caution against transfer payment arrangements except in information technology projects. Transfer payments may assist such projects because they may incentivise contractors to keep their technology up to date during the contract period. This may encourage more suppliers to bid for the next contract as those without the new technology will be able to acquire it without any disruption to the service provision.
3.37 There can be, however, potential drawbacks with transfer payment arrangements. Firstly, if the transfer payment is set too high this may deter suppliers from bidding for the next contract. Alternatively, if they do bid, their prices, after taking account of the transfer payment, may not represent value for money or they may not be able to afford to make further improvements to the systems. Secondly, there is a risk that the original contractor may be paid twice for the assets if the contractor receives the transfer payment but has already recovered part or all of the cost of the assets in his original pricing of the contract or in subsequent price variations.
3.38 Given BT's dominant market position, and the reliance which other suppliers may need to place on BT's systems, the scale of the transfer payments in this contract, at up to 30 per cent of the annual contract spend, may deter other suppliers from bidding in future contract competitions. Also, as BT will have a strong chance of winning future competitions but cannot be sure of this, it is to be expected that they will seek to recover their investment in assets during the existing contract period. This is evidenced by the prices charged over 10 years being less than over 5 years, in part because BT can recover their investment over a longer period. This means the transfer payment arrangement is unlikely in itself to incentivise BT to invest in new technology but could result in them being paid for transferred assets both through annual service payments, and through transfer payments if the Department choose to award the next contract to another supplier.
3.39 The Department note that an incoming contractor is not bound to use BT's assets13 and that, where BT's assets are used by the new contractor, the agreed formula for calculating the transfer payment will at least place a limit on the amount that BT can receive for their assets, based on a percentage of the annual contract cost. In addition, BT will only receive this amount from an incoming contractor whose bid, after taking account of any transfer payments for BT assets they choose, has been judged by the Department to be superior to BT's bid in the future competition.
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13 Subject to the conditions outlined in paragraph 3.35.