THURSDAY 1 MARCH 2001 _________ Members present: Sir Michael Spicer, in the Chair Mr Nigel Beard Mr Jim Cousins Mr Michael Fallon Mr David Kidney Judy Mallaber Mr James Plaskitt _________ MEMORANDUM SUBMITTED BY THE ROYAL MINT EXAMINATION OF WITNESSES MISS MELANIE JOHNSON, a Member of the House, Economic Secretary, DR PAUL MILLS, Head of Debt and Reserves Management Team, MR PETER SCHOFIELD, Head of Public Enterprise Partnership Team, and MR MICHAEL SWAN, Head of Tax Administration/Chancellor's Departments Team, examined. Chairman 114. Good morning. (Miss Johnson) Good morning. Could I explain, first, that the reason why Peter Schofield and Paul Mills are both here is that they represent the two sides of the Treasury's engagement with the Mint. We have split our engagement with the Mint and Paul Mills represents the client of the Mint, as it were, and Peter Schofield represents the shareholder interest that the Treasury has in the Mint. 115. Beginning with a general question, as you know we held evidence in Cardiff with the Royal Mint so a number of questions have arisen out of that session. Given the fact that the Royal Mint is essentially a commercial operation and has trading fund status, and given that it would seem to be doing its commercial work with decreasing success, if I can put it in those terms, why should it remain a state-run operation? Why not privatise it? (Miss Johnson) It has become an increasingly commercial organisation and it is certainly our aspiration for it to be a very commercial organisation, but the fact is that I think a few years ago it was not running on a very commercial basis and we have been making moves to put it on a more commercial footing. There were a variety of reasons for not privatising it but one of the key reasons was that it was not on a significant commercial footing at the time. I think a number of reasons went into that. The Mint's status was reviewed last in 1998/9: and the decision was that we should concentrate more on making the Mint more commercial and more effective in the public sector; that privatisation would have been difficult because the Mint had a large change programme and a large degree of investment that was about to start or had started, of which you will be aware, and it was hard, therefore, for investors to factor the result of that investment into any possible privatisation. Of course, also, the Treasury does have a customer relationship with the Mint as well and that needs to be taken into consideration too. There have been similar reviews I understand in 1990 and 1993/4 which reached the same conclusion: that it was not appropriate to privatise. 116. That is very interesting answer because it suggests that some of the barriers to privatisation, namely its commercial status and the big investment programme and the effect of that, have now been removed. Would it be true to say that the door is more open to privatisation now? (Miss Johnson) No. That would be to speculate. The next quinquennial review of the Mint will be in 2003/4 and at that time, as with all these quinquennial reviews, we will fundamentally go through all the options that could conceivably face the organisation. Those routinely include the option of privatisation and it will be looked at in just the same way that it has been looked at before. It is true that the Mint will be -- and hopefully already is -- on a more commercial footing than it has been but it is also true that we see it at the moment continuing in the public sector but on a more commercial footing. 117. You did mention that the lack of commercialisation or the embryonic commercialisation was a major factor in determining that it will remain in the state sector. Will you concede that that is now less of a factor? (Miss Johnson) I agree they are becoming more commercial; there is still some way to go but we have made progress on that. That is one of a number of factors which led us in the 1998/9 review to come to the conclusion that we came to. At the moment our considered view is that the Mint has a continuing role in the public sector but on a more commercial footing than in the past. As I said, it will be looked at again -- as it routinely is on the quinquennial review basis. Chairman: Perhaps we should look at how successfully it has been operating in the public sector and come back to that question. Mr Fallon 118. Minister, you set the key performance targets for the Mint. Why was the key target for the rate of return on capital employed not set until well into the current operating year? (Miss Johnson) The Mint has gone through a period of substantial change and, if you visited it, you will have seen the results of a lot of that change in Llantrisant. The Mint had a period of substantial investment going on and it therefore seemed sensible to make sure that we were aware of what issues were arising out of that before the targets were actually set. Ideally targets ought to be set at this time of year and that is certainly what we are planning in this present year. 119. In effect, for the current year you lowered the target for the previous year when it was 14 per cent and the Mint only made 5 per cent. You have lowered it now to 7 per cent. Do you expect them to meet that? (Miss Johnson) We do, yes, of course. There is no sense in setting a target unless we expect the organisation to might it. 120. But Mr Holmes told us that he would not? (Miss Johnson) Well, you asked me what I expected and I am telling you what I expect. When I set a target I expect someone to achieve it. 121. But we are ten months into the financial year, so you expect him to make 7 per cent? (Miss Johnson) He may not make it but you asked me what I expected and I gave you an answer about what I expect when I set a target. 122. Fair enough. The other targets are customer service targets and so on. You do not, it has been pointed out to us, have targets for sales to central bank or trade customers. Why is that? (Miss Johnson) The targets that you have are the public targets, as it were. There are confidential targets as well but we have concentrated on areas which we thought were appropriate both to share publicly - and which obviously are shared publicly annually - and which were also fundamental to the Mint's performance and could be shared. Obviously some matters are commercially sensitive, could not be the subject of public performance targets and could remain part of the confidential element of targeting. 123. But in assessing the Mint's performance, we found it quite difficult to see how well the Mint was doing when it does not, for example, publish information about the overall profitability of its collector coins division. We were told that there are obviously bits of that are commercially sensitive but there is no overall figure for the contribution that the collector coins division is making. We were told it ran into millions but no figures were given. Is that satisfactory? (Miss Johnson) Yes because, ultimately, it is an organisation that is working in a commercial setting: it has competitors so information is commercially sensitive. I obviously am aware of what the figures are: it is not that they are not shared with ministers -- ministers are aware of those figures and I am aware of them throughout the course of the year -- but it is not thought to be appropriate because it could be damaging, commercially, for the Mint. 124. But there are other figures not there. There is nothing on the total of royalties you get from the Royal Mint: no figures on marketing expenditure: you may see some of this information but it is difficult for the outside world to see whether or not something that enjoys a monopoly status is performing well or not? (Miss Johnson) It only enjoys a monopoly status with regard to the government being its customer but not at all with regard to the work which it does in winning contracts with -- mostly obviously -- overseas governments of one kind or another to produce coinage for other countries. 125. But overall this is an organisation that has a turnover of œ95 million and made last year a profit of œ345,000. Without the profits contributed by the collector coins division, this organisation presumably would go bust? (Miss Johnson) The effect of the investment in the Mint, and Roger Holmes spoke about this when he was giving evidence to the Committee, was probably underestimated in terms of the difficulty of doing it and what it meant for retraining staff and for changes in practices. It was a very substantial programme and it has had a substantial effect on the Mint initially of a kind that will affect their performance downwards. More recently, though, we have managed to produce a very substantial upturn in the number of blanks, for example, and coins that are being produced and the investment is beginning to bear fruit, but you are looking at a period where the input of investment into that organisation which had very little investment of a capital kind and very little change over a long period was very substantial and was perhaps a bit underestimated in terms of its consequences and the difficulty of settling it in by the Mint and Mint management. 126. We saw the extent of the change programme that has been going on over the last two or three years, yet the overseas programmes were the lowest for twelve years? (Miss Johnson) That reflects the fact that the commercial environment in which the Mint is operating is now much harsher and more realistic than has been in the past. The Mint recognises that there is a change in climate and that they need to respond appropriately to that. In the past, there were a significant number of contracts that were not done on price but, between the Mint and others, on the basis of previous contact and, indeed, contracts and quite a lot of their business came in this form. It is much less the case now that that happens: much more is being done on price -- that is commercially right -- and the Mint will, and is, responding appropriately to that challenge. 127. It is difficult, however, for the outsider to assess whether this whole monopoly organisation turning over œ95 million, would not be better served by simply selling coins to third parties who take on the commercial risk. Might that not be a better route if they do not have the commercial information that you would expect to see in a company report? (Miss Johnson) That is why we have quinquennial reviews. Obviously the reporting for those reviews does enable people to know that a thorough analysis has been done every five years of the basis of this organisation, whether operating within the public sector or whether it is privatised, and whether the nature of this structure and organisation of the performance within the public sector has been thoroughly examined. On all previous occasions, from 1990 onwards, the conclusion has been drawn that it should remain in the public sector. That is not to say that a different conclusion could not be arrived at, but the fact is that at the moment we certainly see that as being the status quo. Mr Kidney 128. Three and two years ago there was a massive capital investment in the works at Llantrisant which the management did through the change programme. Was it not obvious that that change programme and its investment meant there would be massively-reduced profits in the works? (Miss Johnson) In the sense in which you have just employed a lot of capital which was not previously employed then there is an obvious truth to what you are saying. In terms of the difficulties, as I was mentioning earlier on, of introducing that technology, introducing the manpower or staff changes that were necessary and the training that was necessary, there was some underestimate done of the complexity of that and how easy it would be to bed it all in. 129. Presumably the Treasury approved the change programme? (Miss Johnson) Yes. The change programme was initiated in 1997 and the investment has taken place over the last few years. There was an initial investment from the summer of 1997 to the summer of 1999, and there is a further projected increase. 130. We have heard from Mr Fallon that the return on capital employed just two years ago was still set by the Treasury at 14 per cent so in terms of attributing blame for failing to meet returns we can firmly pin the blame on the Treasury, can we, for an unrealistic return being set? (Miss Johnson) No, and the returns are set over a rolling three-year programme anyway. It is because the Mint's business fluctuates quite a lot, and the cash flow does as well, depending on which contracts are being done when and when payment is being made for them. It has always been the view that we needed to have a rolling three-year figure and it is the rolling three-year figure that is the most significant one. 131. In the years before that change programme, the Royal Mint as manufacturer had a position that would be the envy of most British manufacturers -- it had no external debt, it had an excellent return on capital and profits -- and every year the Treasury was pinching all of the profit; 100 per cent went into the dividend back to the Treasury and as a result there was no investment in capital in modernising that plant all through the 1990s except what they could mask from the Treasury in depreciation charges. Is that terribly bad management by the Royal Mint, or is that the Treasury tying their hands behind their back so they could not do what any decent management would have done? (Miss Johnson) It is perhaps not the most modernised way of dealing with the issue which you are raising and I think there is scope for us to look at a change to that which provides greater incentivisation. I think the arrangement historically has not provided as much incentivisation as it could. 132. There is also the freedom of management to manage and make that decision to invest. As you have pointed out, on one side you have the owner of the Mint and on the other you have its main customer advising you. Who is going to win? (Miss Johnson) We - and I in particular - have to balance those two sides. Clearly on the one hand we need coins supplied; we need them supplied cost effectively; and we need to make sure that on the other hand the government is getting a reasonable return as a shareholder, as it were, in the Mint and we need to make sure that it stacks up as a sensible proposition from the taxpayer's point of view. So we need to wear both hats, and it is a balance to be struck. I do not think an ideal balance has been struck in terms of the investment issue and it is possible that we may need to move to a better balance on that. 133. Specifically, last year was the year to re-negotiate the five-year contract for UK circulating coins which the Royal Mint provides all of and the Treasury negotiates the contract. Which of these two advisers did win last year? Did you get the lowest price possible for the customer or did you get a decent price to make a profit for the manufacturer? (Miss Johnson) We did discuss these matters with the Mint and I think I need to point out to you, in response to the earlier points you were making, that a lot of the targets and the returns and so forth are based as well on the Mint's own corporate plan and on discussions with the Mint. There have been discussions: this is not a decision made in the Treasury in isolation in some way from the Mint: these decisions are made in discussion with the Mint and they need to bear in mind both sides of the issue, as I have already outlined. 134. This is quite important, though. Mr Fallon made the point that in recent years it is the collectors coins that have been making the profits and have been cross-subsidising, in effect, certainly last year the rest of the activities. Did last year's contract with UK circulating firms correct that so that that contract will enable the Mint to make a profit on it, or are they still going to be dependent on a cross-subsidy from other activities? (Miss Johnson) I think the coin contract has a net cost to the Exchequer but let me ask Dr Mills to comment. (Dr Mills) As far as I understand, the contract was set up to price coins so that the Mint was going to be able to make a satisfactory return on capital that is higher than what it is currently doing. Obviously we make those payments and then, if there are production difficulties in other parts of the Mint, that reduces the overall return on capital. The contract we negotiated last time, however, did involve a reasonable return on its capital built into the assumptions. We are not saying that cheap coinage is the be-all and end-all; we are saying it is reasonable for the Mint to make a real return on its contract with the Treasury for coinage and then, if it makes other returns elsewhere in its business or problems arise meaning its overall cost of capital falls, that is in a sense the Mint's responsibility. The move to more commerciality means that I have got to think about setting a long-term contract that I might do with another supplier for five years; there will be a reasonable profit expectation built into that and, if there are other problems with the Mint with other costs or whatever, then essentially that is for the shareholders and the Deputy Master of the Mint to sort out. I, as a customer, expect to pay a reasonable return to the Mint for its capital employed and I do not think that I ought to bail out other bits of the Mint if there are problems. 135. Did anybody from the shareholder panel or the management at the Royal Mint give you a hard time over the negotiating of this contract? (Miss Johnson) Not so far as I am aware. (Dr Mills) Unfortunately I did not negotiate this; it was before my time. As far as I am aware, no. (Miss Johnson) We have had very constructive discussions with the shareholder panel; they are an asset to the Mint and very useful from the Treasury's point of view in having a real input there into the strategy and planning. They are playing a very valuable role. 136. I do not know that it is very reassuring to know that they gave you a hard time; for me that is very worrying because I would have expected them to give you a hard time. I do not like the Chairman asking you questions about the privatisation of the Mint, but I feel very uncomfortable about the same organisation being the owner and the main customer. I think there is a difficulty there in getting decent management and history over the last few years shows what happens if that management is poor. (Miss Johnson) I do not think it is entirely fair to say it is poor management. There are a number of ways in which we have addressed what we think has been less than satisfactory. I did talk about the wider, commercial freedom and the importance of addressing those issues but there are also other issues, one of which is the shareholder panel and the value of having the private sector and the manufacturing-based experience of the members of the shareholder panel and the non-executive directors as well, who have a lot to offer in the Mint, and we have strengthened the non-executive director side. The Mint is now working in a more commercial environment than it was before and it is having to change to reflect that commercial environment. It has not had a significant capital investment of the kind that has just gone into it for a long time; that capital investment makes a substantial difference and it has lacked that until recently. They have also done a lot internally on team-working and on getting things right first time in terms of manufacturing process and other matters which they may have told you about. I think there are many reasons why the performance has not been as exciting as it could have been in the last year or so but they are not, I do not think, to do with the dual role that the Treasury holds through me. I have to hold both bits of this role but the two officials who are here belong to different parts of the Treasury, so that the customer and shareholder role is quite considerably split and they are able to discharge their different roles without having to look two ways at the same time. (Mr Schofield) Responding as well to Mr Kidney's point about the way in which the contract was put together, the fact that the role has been split and that my team now has a shareholder role has enabled a greater degree of transparency to come into the debate, and that debate is articulated and explained to ministers and that has been helpful. As the Minister says, the introduction of the shareholder panel gives us greater access to expertise and has been very useful in terms of enabling us to ask the right questions and to get to the heart of the issue from the shareholder point of view. 137. You mentioned a corporate plan. Is that before you now for consideration? (Miss Johnson) It is in the process of being before me, as it were. It is not far off being before me but it is not before me at this moment, no. We have had substantial input to this year's corporate plan both from the shareholder panel and from outside consultants in terms of strategy, so a lot more work has gone into making sure that we have a longer term view built in behind this year's corporate plan. 138. Historically it is not published for reasons of commercial confidentiality, but is there not a way in which the corporate plan can be seen by the rest of the world without the commercial confidentiality bits being made public? (Miss Johnson) There may be. We would have to think about how that could be done in a way that would be useful and would not be a problem for the Mint. Mr Fallon 139. Coming back to the rate of return, the 1999/2000 rate of return you said was 14.6. That was not part of the three years; that was the first of the single-year targets, was it not? (Miss Johnson) We have a rolling three-year target. (Mr Schofield) The 1999/2000 target was a single-year target following on from two periods of three-year rolling targets set at 14 per cent. 140. That is the point I am making. You broke away from the three-years; you set a single-year target of 14.6, but the result was 0.5 so somebody got it wrong. (Miss Johnson) Yes, but it was informed at the time by the Mint's own corporate plan. It was not the case that it was set by the Treasury in isolation from the Mint. As I explained, a lot of the difficulties of the major investment programme and the changes that were necessary which are now bedding down satisfactorily have caused the situation that we have got here. 141. The Mint told us they were now - and I think you presented an order to Parliament to allow them to do this - moving into the area of doing gifts and collectibles and trinkets of all kinds. If we do not have this kind of information in the annual report about marketing and overheads and so on, it is very difficult to assess whether it is really right for a state organisation to be competing against the private sector by producing trinkets like this. Should the Royal Mint really be doing this? (Miss Johnson) The shareholder panel certainly believes that it is a good development. It has been enthusiastic about it and would like to see it extended which is interesting because they obviously all have extensive private sector backgrounds and are recently appointed. I think to call it trinkets is unfortunate. They are and have always had a collectible coin division, as it were, or in recent times did, which is obviously not producing coinage as such but producing purely for collectors: they produce a number of coins both for the UK and for overseas contracts which are never going to be part of the standard coinage but are only for collectors, and they have been extending this business because it has been a good business and a profitable one. It is appropriate for them to be undertaking this in a more commercial setting, which is the one we believe they need to be operating in, and we feel it is one of the right ways for them to develop for the future. As I said, that view is strongly shared by the shareholder panel too. 142. But do you see the danger in them engaging in that activity? Essentially these commercial trinkets, gifts, should be produced by other houses, by other businesses, and there must be a point at which a state organisation should not be allowed, in a cross-subsidised way that is not properly reported in its accounts, to get into that kind of market place? (Miss Johnson) What they are producing is associated with their role as a Mint still. Clearly it does not make sense for them to produce items that have no connection whatsoever with their own collector coin customer base and does not resonate with the Royal Mint. It is within that framework that the business is being developed. Chairman 143. In answering various questions which you have kindly answered for us today, you have identified, it seems to me, at least four roles for the Treasury: the shareholder, the customer, the controller of investment, as Mr Kidney pointed out, and also it has just been introduced as the protector of competition, with respect to the Mint. You have said that these various functions can somehow be kept behind Chinese walls, if Chinese walls are allowed in the Treasury, and you are confident that that is the case. (Miss Johnson) I have identified two prime roles: you may wish to make further distinctions but I am not sure I particularly recognise them. Some of the matters you are talking about are very much shareholder extensions of the shareholder role, and there is a basic distinction between the Treasury's role as a shareholder and its role as a customer. That is recognised organisationally between the fact that if I am dealing with one side of the Mint I will normally have one set of officials, Paul and his colleagues, coming to see me and advising me and if I am dealing with the other aspects of the Mint it will be Peter Schofield and his colleagues who will come to advise me. They are completely separate, therefore, and I think the arrangement is working well, and there are not the number of focuses which you have tried to suggest there might be. 144. Surely the competition element has to be in the mind of the Treasury ministers. If the Royal Mint really did decide to go berserk on its trinkets and produce chocolates, the Treasury would presumably have a view about that? (Miss Johnson) They cannot cross-subsidise because we do take the profit and so it cannot. 145. So you are saying it can do anything so long as it is cross-subsidising who does? Is that what you are saying? (Mr Schofield) In terms of the movement into different types of market there are two things I would say. The first thing is that these are competitive markets that it is moving into. From the point of view of shareholder I think the key issue for us is the degree of commercial risk that it would be taking on in doing so. In terms of looking at proposals that they have put forward, we take a robust and rigorous look at the proposals they put forward as part of the corporate plan. With the expertise of the shareholder panel we will assess if this is the sort of business that the Mint should be moving into. We look at that as a shareholder, we also look at it as a funder, as a banker in that sense. 146. I can see you looking at both those roles and I can see there is a distinction made between them, although I have a question to ask about the credibility of that distinction. The question still remains that neither the shareholder or funder is the proper person to answer as to how far it can stray into competitive markets in a way that most people would assume is unfair competition. That must be a concern of the Treasury. That is at least one other dimension that the Treasury is concerned with. (Mr Swan) I would ask why you would say it is unfair competition in one sense because we have now moved to a situation where if the Mint does borrow from government it is going to be charged a commercial rate as if it were in the private sector. It is not allowed to retain huge amounts of profits that it is not investing and so it cannot use retained profits from other contracts to then cross-subsidise other business. 147. I am aware that time is running out and I do not think a long-scale philosophical discussion about whether the state is borrowing fairly or unfairly against private companies is quite in order, but it is certainly an open question. The final question I have got does specifically relate to this distinction between the shareholder and the customer. Although you have provided us with examples of two representatives within the Treasury it ultimately comes to the Minister. How credible really is it in people's minds that there is this distinction between customer and shareholder? At the end of the day the buck stops with you, Minister, and you are one person. (Miss Johnson) Yes, and a balancing act has always had to be done on this front by Ministers over years. Nothing is different from what it has always been with respect to the Mint in this regard. There is nothing new about the situation at a ministerial level from what it has been, I will not say for time immemorial but for some time before, because clearly what has always happened is that there is a tension between the taxpayer getting a very good deal and the Mint as a supplier of coin to the Government, and that tension is always going to continue to exist. But that is a tension on which I do have good independent advice from both sides in arriving at the judgment about what the balance at the end of the day is to be held on. 148. It is precisely when that tension becomes too extreme that governments around the world have found it easier to split off the two functions. (Miss Johnson) A large number of governments have their own mints but I have not done a survey globally of it. Chairman: Thank you very much indeed.