Thursday, 11 December 2008

Capita/IBS – OFT’s final text - what next?

The OFT has finally published the text covering their decision to refer Capita’s acquisition of IBS to the Competition Commission.

In my mind, the text does little to change my views expressed in my earlier
blog item that, based on the criteria used by the OFT, it had little choice but to refer the acquisition to the CC on the basis of the reduction in competition. However, there is some interesting narrative on the various arguments and discussions that have clearly taken place during the investigation period.

One such discussion was clearly about Civica’s position in the Revenues & Benefits market and the competitive nature of their offering. “Capita submitted that Civica is a longstanding competitor in the market for R&B software services and that 3i Investments plc's recent acquisition of Civica would give Civica access to substantial capital for business development. Capita also stated that the Civica product has received good ratings and therefore has good referenceability.”

However, in discussions with others, OFT found that “third party responses did raise serious questions in relation to Civica's position in the market, highlighting its limited intentions with regard to competing for new work and perceived shortcomings in the quality of the product on offer which would require significant investment. The OFT has no evidence on which to conclude that Civica is likely to present an increased competitive constraint in the future. [REDACTED].”

(By the way redacted – I had to look it up – means ‘confidential information that has been removed from a document’). I can but guess at the further information, presumably about Civica’s product, that was removed.

Further on there is discussion about new entrants to the market:

“Capita considered that the most likely new entrants to the market are companies which already supply software, particularly financial software, to local government. Capita also stated that providers of software for use in social care have the necessary expertise to enter. Capita estimated the costs of entry for these players to be in the region of [<£2 million] as they already have the necessary expertise. It argued that a new entrant could enter the market within a year to 18 months given the pool of available staff.”

However, “the OFT's investigations have cast significant doubt on the potential for new entry into the R&B segment. Specifically, the OFT has been made aware that the costs and time involved in entering the market with a new product are significant at around £2-10m and two years respectively.”

Having had personal exposure to the costs of developing both financial and R&B systems, I would put the estimate at close to the £10m upper limit quoted by the OFT, and most probably an elapsed time well in excess of the two years quoted.

Given that there will be very few new tenders over the coming years (most Pericles customers will no doubt try to stay with Northgate, leaving only a small number of Pericles sites and the Civica sites yet to purchase new systems – Capita estimated “that the value of contracts expected to come up for renewal (where the OFT's concerns lay) was £[1-2] million for 2009”), I can’t see anyone producing a business plan that would be approved in a normal financial environment let alone the current financial climate.

However, an even bigger concern for new entrants (and existing suppliers considering a major speculative investment in the R&B market) is the serious risk that Central Government will totally change one or more of the areas (I suspect that the area of Housing Benefits is the one causing the most concern), potentially destroying the future market for new systems overnight.

And what would Central Government do if it were to introduce a new method of collecting revenue or supplying benefits (e.g. to replace HB)? Bearing in mind that many of the replacement R&B systems over the past few years have been largely funded by Central Government, no supplier is likely to start any development without their support. Given the current government’s apparent preference for single suppliers in such situations, no doubt there would be a competitive tender for a single supplier (I can’t see Central Government funding two or even three suppliers to develop competing systems to fulfil the same requirements).

So perhaps having two strong suppliers of R&B (i.e. Northgate/Sx3/Anite and Capita/IBS) is a luxury compared to the future of potentially having a single supplier....

Meanwhile, there will undoubtedly be many months (years?) of uncertainty before the CC rules on the acquisition and, if it rules against it, decides and agrees on the remedies. Then we may have a new government, possibly new R&B policies, and a whole new ballgame. In the meantime we will have one supplier hobbled with the costs of running two sales teams and maintaining separate teams with Chinese walls – inevitably incurring increased costs that will eventually be passed onto the customer....

Given the specialist nature of the R&B market and the control that central government retains over it, the CC should make a rapid decision to allow the acquisition to proceed with some levels of protection as offered by Capita in its submissions to the OFT. As with the OFT decision, my concern is that the CC will be constrained in what it is allowed to do, and that it will require a senior government decision, taken quickly, to resolve this situation – and that seems unlikely at the moment.

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