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Rural Broadband, National Audit Office (NAO) find 38% excess costs in BT’s financial models. Broadband Delivery UK concedes it has yet to find the most economic price!
12:02pm - 11/02/2015

Updated with an introduction on 11/2/2015,  and further reason why the excess modelled cost are likely to grow, and a summary statement.

This is note is intended for those with an interest in the UK rural broadband programme,  particularly those interested in getting the most from the £1.7bn of public monies invested.  It does not question the contract letting process or the awarding of the contract to BT.  It comments on the findings of the two NAO reports done to date and suggests the next steps needed to ensure the public monies get invested where they were intended.  Feel free to use the information to further the public interest. I would welcome comments by email to Mikekiely01@btconnect.com.  I would be delighted to correct any errors and improve the public record where evidence emerges  to support any substantive changes.

This note alleges and attempts to prove that the £142m excess modelled costs identified by the NAO to September 2014 have already been paid to BT by Local Authorities using the BDUK Framework negotiated just before the 2012 Olympics in the form of invoices for milestone payments. The invoices for milestones payments expressed in terms of premises past are largely unrelated to the actual costs for the components used now being reviewed by Atkins/BDUK.  The excess modelled costs are likely to increase by an estimated £40m a quarter for the next 4 to 5 quarters and rest in BT accounts until plans for increased coverage in rural areas can be revised well after 2017.

On 28th January 2015, the NAO issued a second report to the Public Accounts Committee on the costs of the £1.7bn UK Rural Broadband programme. 

Phase 1 of the project provides  £1.2bn of state aid to gap fund BT’s fibre to the cabinet (FTTC) overlay network to some 5m premises in some 30,000 communities in areas not covered by BT’s commercial investment. The Rural Broadband programme is a 4 year programme where every week a further 40,000 premises can connect to some 160-200 new green cabinets using  200-300km of fibre to connect to BT’s high capacity core network.

The information provided by BT and BDUK to inform the NAO’s first report in July 2013 looked and read like a joint plausibility exercise. The NAO found it wanting, and the Public Accounts Committee meetings called to discuss the findings were even more critical. 

I should declare an interest; see;: http://www.theguardian.com/technology/2012/oct/03/whistleblower-sacked-bt-broadband. So it was with some relief that the NAO’s second report, a year and half later (Jan 2015), found evidence that BT had inflated its cost models by 38%, and BDUK, the government agency, is even now not  convinced it has BT’s best price. This is likely to be the start of the difficult task of proving that BT has abused its monopoly position, and that it has hidden the details of the rural broadband project behind 44 separate and pernicious commercial confidentiality agreements with local county councils.

The first NAO report in 2013 found subsidies that averaged some £46k per VDSL cabinet and fibre path.  The subsidy, in the form of milestone payments, is much higher in Wales, in fact more than £60k for each VDSL cabinet. The Welsh audit office is reporting separately on this in April 2015.   

These estimates included premiums for the universal service commitment of 2Mbps.  BT’s quarterly results have reported state aid of £94m for each of the last two quarters. The latter is consistent with milestone payments, driven by inflated cost models, of c£200 per premise passed.  The NAO in its latest report have identified actual costs closer to £104 per premise passed and an emerging cabinet and fibre path costing an average of £21,000.  This number in my opinion excludes the 23% contribution from BT so the ‘should’ cost to the taxpayer ought to reduce to £16,170 which correlates with  the The Bit Commons subsidy estimates presented to NAO for its first report.  These were dismissed by DCMS but thankfully not by the NAO.

The second report noted that these are the easy to do cabinets and it will get more expensive.  There are at least four counters to this belief. 

BT’s network is homogeneous to about 90% coverage at a national level, so economies of scale will continue for some time.  Therefore, the £142m the NAO identified as excess modelled costs, which are included in the milestone payments on a job that is 26% complete, are, in my opinion, likely to grow at the rate of £40m a quarter for another four to five quarters. 

The second, more sensitive point is that BT was to provide 23% of the capital cost directly; this has not been mentioned in the NAO comparisons between modelled costs and actuals.  BT’s contribution is self-certified, so this will need to be examined or its status made clearer in the next NAO update.  BT’s contribution could also be addressed in the review of the state aid measure which takes place before June 2015.  Furthermore, it could also be addressed in Ofcom’s financial regulatory reporting consultation, should Ofcom wish to assist the NAO, PAC, EU Commission and BDUK in calling BT to account. 

Thirdly, BT did an excellent job in Northern Ireland, where the subsidies amounted to about £12,500 per cabinet to reach some 88% of the premises.  This included Belfast, but 70% of the money went to areas outside Greater Belfast.

The fourth reason is the costing study is likely to have been done in a rural area, long fibre spines and a low cabinet count.  Why pick a costing exercise for a rural programme in an urban area? 

BT is not yet acknowledging that the milestone payments have become divorced from the actual costs. BT is not acknowledging that the reported state aid receipts cannot be based on actual costs because the invoices become available only months after the milestone is achieved.

The accumulated excess modelled costs,  sometimes referred to as ‘savings’,  are resting in BT’s accounts and are likely to do so through to 2020 as the BT run project is resource-constrained.  Establishing a simple level of transparency on what has been paid in exchange for what,  is not helped by BDUK, which does not report on the total subsidy paid,  but only on central government’s contribution to the subsidy. It neglects to include and report funding from the local authority and EU.  Perhaps this will now change. 

BDUK has added an extra layer of complexity by deciding to contract for additional coverage without first reviewing the actual costs and BT contributions made in phase 1.

The basic deliverables of the project read as follows,  circa 160-200 cabinets installed a week, 200-300km of fibre laid each week, passing some 40,000 premises.  You could call it good, but the public statements are so misleading that one cannot tell how the 40,000 premises are counted or how many will receive a more than 24Mbps service or 15Mbps, depending on the contract.

There will also be gaps in coverage, whether areas outside the reach of a cabinet, or parts of exchange areas which have not been completed. Furthermore the funding available (and this is reflected in how BT chose to present its financial models), suggests it could have employed another 1,500 apprentices when the Framework procurement agreement was signed in July 2012.  The cost of employing these apprentices would have been easily covered by the 38% excess costs identified by NAO, and would have enabled a much more extensive delivery plan.

From a BT shareholder perspective, a deeper, more intense fibre rollout would assist in long term cost removal. Delivering to the rural economy the upgrade it needs would allow the government,  central and local,  justifiably to claim a ‘best in Europe’ for this vital piece of infrastructure.  It would also create the environment for additional public investment provided there was confidence in the cost models and capital contributions made.  Trust, the basis of any functioning relationship, will now be in short supply.

As infrastructure projects go this is technically as easy as it gets. There is no decade of planning or consultation, no compensation and a win-win for both the economy and BT. Or it would be if BT’s cost models were not inflated to absorb the money available,  while failing to resource the project to match the funding being billed.

The overall numbers are easy enough to understand as the BT network is a tree and branch architecture, with published quantities for exchanges, cabinets, and handover points.  According to its guidance to analysts, BT has invested between £1.3 to £1.6bn out of the £2.5bn BT thought it needed to upgrade some 19m premises in its commercial roll-out.  The £2.5bn was not new money but an allocation from BT’s existing capital envelopes used to maintain and extend the existing telephone network. 

Dividing £1.3bn by 19 million premises passed gives you £68 invested per premise.  This is an interesting number; the Connect America rural broadband fund expects US operators to pay the first $70 (£45.90) per premise passed before subsidies kick in.  There is nothing in the second NAO report to show that BT is paying its capital contribution up front, or how it is being accounted for in the costs presented.

Estimating an average cost for a cabinet and fibre path is not too difficult:  BT has 90,000 cabinets (PCPs), of which it is reasonable to assume that statistically 50-55k cabinets serve 19 million premises, leaving 25-30k cabinets to reach the more remote 5m premises, helped by public money. 

BT’s  commercial cost is thus £26k - £30k per cabinet  (£1.3bn /55-55k cabinets), fibre, handover point, core network and all the development costs including operational support systems. 

The Phase 1 publicly  funded £1.2bn BDUK project has a combined intervention areas of approximately circa 5m premises and needing 25-30,000 cabinets. The NAO’s first report, which relied on evidence from BT and BDUK, found the average subsidy was estimated at £40-£48k per community serviced – of which £28.9k was for the actual cabinet and fibre path.  The £28.9k average is important as it is a number BT acknowledged at PAC,  while failing to acknowledge others,  but the report (Table 11, page 33) shows it only represents 36% of the total costs or c60% of the public subsidy.

The second NAO report reports the actual costs running at £21k (excluding BT’s contribution in my opinion), not the £40-£48k subsidy budgeted. But it looks from BT’s reported state aid receipts that BT is receiving the higher number. Presumably this will be reconciled with the lower actuals costs at some later date, provided  local authorities demand and pursue it.  This is separate and in addition to the clawback mechanism in their contracts and should be pursued immediately.

All of this suggests the third NAO report will need to focus on the following;

Verification of BT’s direct investment of £70 a premise or £357m for Phase 1

Identifying and managing the excess costs built into the existing milestone payment process,

Review of how the excess costs have been converted into incremental coverage.

Estimating clawback amounts arising from take-up and reinvesting the clawback.

Reporting on the use of the premiums charged for the Universal Service Commitment or its conversion into additional coverage.

The third report will also need to confirm that the government is actually gap-funding BT in a manner that is consistent with state aid measures, in other words, not close to paying for the project in its entirety. 

What a third report will not do is judge whether,  given the financial resources the government and local authorities have made available,  BT is applying them effectively and whether BT’s ambition is adequate.  With £1.7bn in taxpayers’ money, why will Britons not, as promised originally, have the best broadband in Europe, rather than be only marginally better off than the French or the Germans?  Just a little Churchillian drive would make a huge difference.

When this process began BT had a plan to make fibre to the premise available to a substantial proportion of the population.  BT decided to focus on cabinet based solution which by their design leaves many excluded.  The NAO and BDUK have found 38% excess costs in BT financial models.  These monies now need converting into a more ambitious plan which includes more direct  fibre rich access.  Public monies should not be allowed to rest as some huge contingency, while even more money is contracted to BT.  BT should not be permitted to blag on this matter but called to account using the combined pressure of our public institutions working together to deliver an entirely achievable goal. 

In the autumn of 2013 the then CEO of Openreach repeated on BBC radio  (Strike up Broadband, Dec 2013)  that a FTTC cabinet cost £100,000 each.  The July 2013 NAO report found BT and BDUK supporting numbers of £80,000 per cabinet and fibre path which included a public subsidy averaging £46,000 and an average cabinet and fibre cost of £28.9k.  The January 2015 NAO report has found actual costs of £21,000 a cabinet and fibre path with BDUK convinced it has yet to reach the most economic model.  I am equally convinced the £21,000 excludes any direct contribution from BT and so this number should drop to circa £16,000. The third report should it be completed will find more of the modelled excess costs.  The pretence, blagging and bluster is preventing a much deeper delivery of fibre rich access solutions. 

With the second report, NAO and BDUK now agree and have sight of the excess costs in BT’s financial models.  They now need support from Ofcom, through the financial regulatory reporting process and the EU Commission, through a revised state aid measure to ensure the identified excess costs already paid of £142m, and those that are likely to accumulate in the next 5 quarters at an approximate rate of £40m a quarter actually reach the rural economy and are not held up in BT’s accounts.

Finally, special thanks to those who peer reviewed this note.  I hope it is useful to anyone contributing to the rural broadband programme,  especially those trying to manage the programme day to day.  This includes many BT folk who make informative material available online.

 

Mike Kiely,  Feb 2015.
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