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The Public Accounts Committee (PAC) has recommended that HM Revenue and Customs "rigorously benchmark" its 10-year deal with Capgemini after a steep rise in its revenue and profits from the deal after only three years.

The contract HMRC awarded Capgemini in 2004 allowed the department to consider price changes if additional work was undertaken, said the PAC's Twenty-Eighth Report of Session today. The estimated cost of the contract had risen from nearly £3bn to £8.5bn over 10 years.

"If profits continue at this level, Capgemini could make £1.1bn profit on the contract as a whole compared to the £300m initially envisaged," said the report.

PAC chairman Edward Leigh MP said in a statement: "The Department should have foreseen that its demand for IT services could vary significantly and determined how this might affect its contractor's prices and profit margins. These will have to be rigorously benchmarked in future to make sure the prices fairly reflect the actual volume of work being carried out."

£900m of the cost increase had come from the assimilation of a Fujitsu PFI contract, but the majority had come from extra demand for IT services, additional projects, the merger of Revenue and Customs departments, and the transformation programme, which required online services.

HMRC acting chairman Paul Gray told a PAC hearing in December that he would not have negotiated a different deal with Capgemini had he known in advance that profits and spending on Aspire would have increased so much.

"We are satisfied, as the National Audit Office report brings out, that the margins that we are paying on those types of work are well within the margins on other similar contracts."

The report also revived questions about a payment of nearly £52m HMRC made to cover the costs to Capgemini of taking over the contract from EDS. Capgemini earned a 15.5 per cent profit margin on the sweetener, which had been intended to encourage competition by attracting bidders.

Leigh said it was hard to justify the £52m payment. In future, more should be done to find other ways of encouraging competition.

"The Department could also have been sharper in its negotiations. The actual costs of transition were agreed after the contract was awarded and competitive tension had vanished. In addition, part of the costs of transition related to NIRS2, where the original supplier Accenture carried on as a subcontractor," he said.

Gray had told the committee in December: "This is one of the areas where it is appropriate to seek to draw lessons from our experience."

However, the report noted that overall profit margins earned by Capgemini had been below a threshold agreed in the contract that would trigger a profit-sharing arrangement between HMRC and Capgemini.

In the first year of the contract, between July 2004 and June 2005, HMRC's spending on Aspire increased from an estimated £384m to £539m. Profit increased from a projected £52.8m, "marginally lower than predicted", said an HMRC memo to the committee. The profit margin was 10 per cent, less than the target of 13 per cent. Capgemini earned an overall profit of £362.6m in the financial year ended 31 December 2004.

Numbers for the second year of the contract to June 2006, which are still being calculated, show costs of £767m. Profits were £90m, a margin of 13 per cent. The target profit margin had been over 14 per cent.

HMRC estimated that costs in the third year would be £840m, and it said cost increases were attributable to STRIDE, a common desktop environment for the merged departments, the development and implementation of a "major" Enterprise Resource Planning System, and the merger of Aspire with ISA, another IT contract.

Overall, the performance of Aspire had been "good", said the report. Ninety per cent of its projects were being delivered on time against a target of 75 per cent. Gray told the committee it represented good value for money. The committee said value for money could have been better judged and it would ultimately be dependent on close management of costs and performance over the life of the project.

XANSA, a Capgemini competitor, said in a submission to the committee that better value for money might be gained from letting smaller contracts to more suppliers.

"Xansa advocates that the single partnership sourcing model of this size cannot secure value for money and does in fact distort the market, stifle innovation and can increase complacency," said Gavin Hall, principle government consultant at Capgemini.

"Going forward, the select committee should ensure that large service contracts are not the norm and should encourage more agile forms of contracting to ensure healthy competition, a healthy market and value for money after day one."

The Public and Commercial Services Union said HMRC was being used as a "cash cow" and criticised the increase in Capgemini's profits and HMRC's need to stimulate competition, all the while cutting 25,000 jobs. ®

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