Devil's Advocate: Taking risks

When Martin Brampton recently wrote about risk sharing within PFI contracts his inbox soon filled. Can private companies shoulder the burden for large and complex IT projects? Still not sure?

Not long ago, I wondered about how much risk is really being handed over to the private sector by government contracts. Problems with the computer system for magistrates’ courts came to mind as an example of a project that seemed out of control. Well, it seems that in this case the supplier was at risk, but that merely demonstrated another weakness in the situation.

There are good reasons to question who is really shouldering the risk in projects that are developed under the Private Finance Initiative. Often, it looks as if there is more financial engineering than real risk transfer. On this particular project, though, Fujitsu Services (once known as ICL) was in danger of heading for bankruptcy.

Trouble is, that merely shows how very difficult it is for government to pass off risk. Fujitsu is, of course, a very large Japanese company that is not in the slightest risk of becoming bankrupt. Yet, because it is structured as a number of individual entities, it seems that Fujitsu Services was in danger of falling into the hands of the liquidators. It is rather remarkable that the government had presumably not sought guarantees from the parent company, but that appears to be the case.

Now government cannot really allow its contractors to go bust, because large sums of money have normally been handed over already, and a significant amount of time has passed waiting for a new system. If a contractor disappears, the software may never be completed, wasting all the time and money completely. Alternatively, if the software is more or less complete, government will find it difficult to use if there is nobody there to tidy up the documentation and support the live system.

Government, on the other hand, cannot go into liquidation. Well, maybe one or two marginal countries could default on their financial commitments, but no major country could do so. After all, even if the coffers are empty, the taxpayer can always be asked for more. So anyone who is relying on the financial stability of a sizeable country is on to a pretty safe thing.

Companies, conversely, often operate on very narrow margins of stability. They do need the use of assets, such as buildings and equipment. But these are often financed by loans, leaving the amount of real risk capital in the company quite small in relation to the larger projects it undertakes.

Giant companies are nearly always broken up into a number of separate corporate entities. Admittedly, this is not entirely for financial protection. There are reasons to do with different legislative practices and different accounting principles that make it easier to have separate companies in the different countries in which a global company operates. All the same, these factors conspire to leave the corporate sector with pretty flimsy financial safeguards if things start to go badly wrong.

Taking into account the realities, there is not much government can do with a bad project other than to write off everything that has already been done, or to cough up more money. Sometimes people have chosen the drastic option of walking away and taking the loss. More often, some kind of renegotiation is the favoured choice.

Where, then, is the risk? Clearly, a major part of the risk has inevitably remained with the financially stronger party to the transaction. No amount of contractual ingenuity can alter the fundamental situation. The idea that PFI involves a sharing of risk does not run deep. Provided the risks remain small, there may indeed be shared risk. But as the risks grow, so does the imbalance that in the end leaves the taxpayer always the loser. We do not necessarily have to abandon schemes such as PFI.

We do need to be sceptical about the grander claims that the private sector is taking on all the risk for major projects.

** Martin Brampton is a director and founder of Black Sheep Research (www.black-sheep-research.co.uk ), an independent consultancy providing research, writing and speaking services on a wide range of business and technology subjects. Martin was previously a director at Bloor Research, and has worked with IT as a user and analyst for over 20 years. He can be contacted at silicon@black-sheep-research.co.uk.

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