The Department has built flexibility into the contract

2.26  Under the contract the Department has guaranteed to buy a certain level of usage from Defence Management (Figure 8). If its actual usage is more than this, then it will pay more, although at a reduced rate to reflect Defence Management's marginal costs in meeting this extra usage. In the first full year of occupation the actual number of student days used by the College has been 7 per cent below the guaranteed levels. The College told us that numbers were reduced on some early courses in order to assist the settling-in process at Shrivenham. Furthermore, with the planned introduction of various seminars and additional courses, its usage should increase in the second year.

2.27  The level of the guaranteed usage is fixed for a number of years before it reduces over the rest of the contract period (Figure 11). The Department told us that it had negotiated these reductions as it had wanted the flexibility to reduce its usage in later years since the historical trend had been for a decrease in the size of the Services. The Private Finance Panel Executive had also advised it to seek such flexibility.

2.28  In pricing its bid Defence Management has ensured that it will recover in full its costs of building the College facilities and its other fixed costs from the income it receives for the guaranteed usage. In response to the declining level of guaranteed usage in later years, Defence Management will have increased its prices to ensure that it recovers early in the contract some of the fixed costs it will incur in later years. Both the Department and Defence Management confirmed to us that  the contract prices would have  been lower  if Defence Management had been guaranteed a constant level of usage for the whole of the contract. Both doubted, however, whether the overall net present cost of the PFI option would have been significantly lower as a result. Other factors would also have influenced the level at which contract prices were set.

2.29  As for residual value risk, the College facilities were built with a design life of 60 years. At the end of the 30 year contract in 2028 either these facilities will revert to the Department at no cost or the Department can choose to leave them with Defence Management. The Department told us that it had negotiated these provisions as it wanted maximum flexibility at the end of the contract.

2.30  Defence Management assumed in preparing its bid that the Department would not exercise its option to walk away and the College facilities would revert to the Department at no cost. Consequently, when calculating its price, it sought to recover the full cost of building these facilities during the contract. The Department told us that it had briefly explored the alternative option of it paying the contractor the facilities' market value for their return as this might have resulted in Defence Management lowering its fee in anticipation of this payment. It had, however, rejected this option as it was opposed, in principle, to making any further payment at the end of 30 years to purchase the building. Also, Defence Management had made it clear that it did not consider that the facilities would have an alternative use and, consequently, a market value. Defence Management confirmed to us that it would have been very conservative in estimating in advance the size of any payment based on market value as the facilities were purpose-built as a military training college in a location which was not ideal for alternative uses. Any reduction in its fee would therefore have been minimal.

2.31  The PFI contract allows the Department some flexibility in dealing with changes in its requirements. For example, if the College were to require new accommodation at its existing facilities, under the contract the College is free to require Defence Management to manage a competitive tender for the implementation of the necessary capital works if the value of these works exceeds £250,000. As a result of the changes in student numbers the College may need such new accommodation in the near future. The College told us that, if its existing facilities did prove insufficient, it would attempt in the first instance to use the other non-College Defence Academy accommodation elsewhere on the Shrivenham site.

2.32  There are, however, limits to the flexibility available to the Department. The long-term nature of the contract inevitably constrains the Department's ability to respond to more fundamental changes. The Defence Academy is to take over responsibility for the whole Shrivenham site, including that of the College, from April 2002 and will be reviewing its strategy for the estate management arrangements. Any plan for the Academy to rationalise these arrangements by, for example, outsourcing the management of the whole site will have to take account of the existing PFI contract for part of that site.