2.20 A reliable model could not be constructed without O2 providing detailed information about the quantities of components and labour, and the timing of when they would be required. In 1997, O2's obligation to provide component and labour quantities was formalised when PITO awarded O2 a contract to undertake a project definition study. The flow of quantity related information, which was dependent upon O2's progress in designing the network, was slower than PITO had anticipated. This led to concerns within PITO that a meaningful comparison with O2's costs might not be possible. Delays to the procurement, however, provided additional time to develop the model and to obtain more specific information about the quantities and costs of what would be required:
a) Quantities of components and labour.In compiling a should-cost model, PITO was concerned that O2 might overestimate the quantities required to deliver Airwave. The strategy to reduce this risk comprised two basic elements. The simpler of the two was a direct comparison with the quantities included in the public sector comparator. This approach was satisfactory for some capital assets such as base stations and switch centres. For instance, O2 calculated that the service required 3,012 base stations, whereas the number included in the public sector comparator was 3,415. The second approach involved using the combined expertise of PITO's in-house team, Home Office personnel and Mason Communications to challenge quantities of components and labour on a case by case basis at meetings with O2. Quantifying labour only activities that O2 intended to outsource proved difficult to resolve, as, for a long time, O2 did not have a clear understanding of what was required. For example, discussions about the amount of software development needed to integrate the various systems in Airwave were concluded in October 1999, two months after the production of the final version of the should-cost model.
b) Costs of components and labour. Some cost information was available from Mason Communications, the Home Office and police forces. Reliable cost information for TETRA equipment proved not to be readily available because the technology was so new. PITO estimated these costs using various sources, including suppliers' indicative costs, consultations with two European public bodies that had awarded contracts for the construction of TETRA networks, and comparisons of equipment costs designed for mobile telephone networks. However, because of different levels of functionality there were considerable discrepancies depending on the chosen supplier. For instance, the price of a switch varied from £300,000 to £1 million. Records of how PITO converted the raw cost information it had it had obtained into figures input into the model were not retained, so we have been unable to verify the reasonableness of the process. As a result, PITO has lost the opportunity to establish a robust database of costs for use in the future. Such a database, if it were to have been regularly updated, would have assisted in pricing future changes to the service and in future benchmarking exercises.
c) Financing costs. PITO envisaged using the cost information to model O2's cash flow and, by calculating the internal rate of return of the project, obtain assurance about the reasonableness of O2's bid. After O2 had refused to disclose how it intended to finance the project, Charterhouse advised PITO to design the model so that the output reflected pre-finance and pre-tax cash flows. Charterhouse also advised PITO to demand a breakdown of costs so that meaningful comparisons could be made. O2 refused to disclose costs on a component-by-component basis, but agreed to provide cost information for six capital and six operational cost lines.