Information Technology – Just and Reasonable
In this decision, the Alberta Utilities Commission (“AUC”) considered whether to approve the prices contained in the information technology master services agreements (“MSAs”) between the ATCO Utilities and Wipro Solutions Canada Limited (“Wipro”) for inclusion in each of the regulated utilities’ revenue requirements.
The AUC found that the ATCO Utilities failed to demonstrate that the information technology (“IT”) pricing in the MSAs would result in just and reasonable rates if included in the revenue requirements. The AUC ordered that the ATCO Utilities would only be permitted to recover those IT costs that were prudent in the circumstances and would result in just and reasonable rates. More specifically, the AUC determined that in the first year of the MSAs (2015) pricing would be reduced by 13 percent. In each of years two through ten of the MSAs, a glide path that reduces prices on a weighted average basis across towers by 4.61 percent would be imposed.
IT Placeholders and Other Related Regulatory Proceedings
A placeholder is created when specific costs for a utility are not finalized because those costs are contingent upon some other event or proceeding. The IT costs included in the revenue requirement for those utilities affected by the IT common matters proceeding have been treated as a placeholder until the MSA prices are determined in this proceeding. The approved IT rates will be multiplied by utility specific IT volumes to determine costs that will be approved for inclusion in revenue requirement in a future rate proceeding. The IT costs for each of the ATCO Utilities will then be finalized and included in revenue requirement and rates.
Scope of the Proceeding and Test to be Applied
The fundamental issue raised by this proceeding was whether the IT service costs under the MSAs should be approved for inclusion in the ATCO Utilities’ revenue requirements, which were ultimately recovered from utility customers through rates.
The AUC found that it was within the AUC’s mandate to consider whether the corporate decisions made by the ATCO Utilities on the procurement of IT services resulted in just and reasonable rates for the ATCO Utilities’ customers.
ATCO Utilities bore the onus of demonstrating, that the inclusion of the MSA costs in the revenue requirements resulted in just and reasonable rates. That was the ultimate test that must be satisfied, failing which the ATCO Utilities were at risk of a disallowance.
The AUC took the view that fair market value (“FMV”) was but one criterion that may be considered. The AUC was not bound to equate FMV with just and reasonable rates, nor was it restricted to considering only FMV in the determination of just and reasonable rates.
Does the MSA Pricing Result in Just and Reasonable Rates?
Sourcing Strategy and Tender/Bid Process
The ATCO Utilities asserted that their IT service sourcing strategy was prudent and resulted in MSA rates that were at FMV. Therefore, the ATCO Utilities asserted that inclusion of the MSA rates in revenue requirement was just and reasonable.
The AUC found that the ATCO Utilities failed to demonstrate that their IT services sourcing strategy was prudent. The ATCO Utilities also failed to satisfy the AUC that it can be reasonably concluded from the sourcing strategy of the tender/bid process employed, that the resulting MSA prices were at FMV, met the least cost alternative and no-harm tests, and would result in just and reasonable rates if included in revenue requirement.
Consideration of Sourcing Options
The AUC’s mandate is to ensure that whichever option is chosen, the costs are prudent, and customers are not paying more than is just and reasonable. The ATCO Utilities bear the onus of establishing both of these things. The AUC agreed that it was ATCO Utilities’ right to determine whether it will remain in the IT business.
The ATCO Utilities must also demonstrate that the MSA pricing was reasonable, that its reasonableness could clearly be determined, and that the price paid was associated with the least cost option that met the needs of the ATCO Utilities.
The AUC found that neither reasonable consideration of the options nor documentation of the decision-making process occurred, and therefore, that the prudence of the sourcing strategy was not established.
The AUC could not come to any reasoned conclusion about whether the chosen sourcing strategy was the least cost option that met the needs of the ATCO Utilities and resulted in costs that were prudent, just, and reasonable.
The Tender/Bid Process
In approving revenue requirement amounts that would flow out of a typical outsourcing contract, among other things, the AUC generally sought to confirm the competitive nature of the process; considered the rationale for selecting the chosen contract; and confirmed that competing parties were under no compulsion to act.
It was reasonable to conclude that all else equal, more bidders would have likely resulted in lower MSA pricing. On this basis, the AUC was satisfied that, on its own, the sourcing strategy (the decision to procure IT services from a provider who would also be required to purchase ATCO I-Tek), had the potential to compromise the achievement of competitive pricing for the MSAs.
The evidence supported that the combination of the sourcing strategy and the actual tender/bid process (running the MSA and ATCO I-Tek sale processes concurrently) was expected to and did influence MSA terms and pricing.
The AUC found that bidders altered their bids in a manner that demonstrated a relationship between increases in the proposed ATCO I-Tek purchase price and in the proposed MSA pricing.
The AUC found the evidence on the degree of separation between the sale and MSA processes contradictory.
The AUC found that neither the sourcing strategy nor the tender/bid process established that the MSA pricing was at the level that would have prevailed under an unrestricted, fully competitive process; that FMV for the MSAs on a stand-alone basis was achieved; or more broadly, that the inclusion of MSA costs in revenue requirement would result in just and reasonable rates.
KPMG Price Assessment and Gartner Benchmark
The ATCO Utilities failed to satisfy the AUC that the KPMG price assessment and Gartner analyses established, individually or collectively, that the MSA pricing was at FMV, involved no cross-subsidization and that if included in revenue requirement, the MSA prices would result in just and reasonable rates.
Lack of Transparency
Gartner’s benchmark approach identified differences between the MSA and the selected peer contracts, and took these differences into account through a normalization process. KPMG’s price review identified key parameters about the MSA, then selected a larger group of peers and offered market pricing ranges without normalization for differences.
The AUC was of the view that a benchmark with normalizations allowed for a more rigorous examination of FMV, while KPMG’s price assessment offers a more high-level perspective of FMV.
The AUC found that there was limited transparency into how comparable peers were determined by Gartner, the empirical size and relative importance of any normalizations applied to the comparator data, and the underlying calculations in the benchmark report.
The AUC found that due to the lack of visibility into these processes, it was not apparent whether or how Gartner (through its normalizations) or KPMG (through its final report) accounted for the term of the MSAs.
The AUC found that this lack of visibility:
(a) restricted the ability of interveners and the AUC to properly examine the KPMG and Gartner evidence;
(b) limited the AUC’s ability to assess whether the conclusions reached by KPMG and Gartner in their respective reports were reasonably adjusted and aligned to the MSAs to provide a meaningful FMV determination;
(c) inhibited the AUC’s ability to effectively rely on either report as demonstrating that the MSA pricing was at FMV; and
(d) ultimately, did not assist the AUC in determining whether the MSA pricing was just and reasonable.
The AUC found that the lack of visibility significantly diminished the weight that may be afforded to the KMPG price assessment and the Gartner benchmark.
Limited to First Year Pricing; Failure to Consider the Total Contract Value
The AUC was unable to accept that Gartner’s glide path analysis demonstrated that MSA pricing was at FMV over the whole of the term.
Benchmark
The AUC concluded that using a benchmark that focused on the mean and not the lowest quartile pricing supported higher customer rates than could otherwise be obtained, and consequently rates that were not just and reasonable.
The AUC also found that the concurrent sale of ATCO I-Tek influenced MSA pricing. The AUC found that MSA pricing was higher than it otherwise would have been as a consequence of the concurrent sale and purchase price for ATCO I-Tek.
10-Year Term of the MSAs
The AUC found that 10-year terms for IT service contracts were atypical at the time the MSAs were negotiated and that a term of this length should have been associated with lower prices. These considerations raised significant doubt as to whether the MSAs were at FMV. Furthermore, the AUC was not satisfied that any risks associated with the 10-year term were mitigated by the other terms and conditions of the MSAs, as asserted by the ATCO Utilities.
The AUC found that the ATCO Utilities failed to provide cogent evidence of the alleged transition risks and costs. The evidence likewise failed to demonstrate achievement of the cost savings reasonably expected of transactions associated with the scale/volume, duration, and other characteristics of the MSAs.
MSA Governance Provisions
The AUC found that the ATCO Utilities failed to establish that any risks associated with the 10-year term of the MSAs were mitigated by the governance provisions in the MSAs.
The governance provisions had the potential to provide for and ensure competitive pricing over time. However, that was so, only if they were exercised by the ATCO Utilities in a timely, reasonable, and prudent manner. The AUC was not satisfied that the ATCO Utilities had done so. Accordingly, the AUC could not reasonably accept that these governance provisions offered some assurance that the MSA rates were at FMV and would result in just and reasonable rates if included in revenue requirement. For the same reason, the AUC was not satisfied that any risks associated with the 10-year term were effectively mitigated through these governance provisions.
Adjustments to IT MSA Service Rates
The AUC found that the ATCO Utilities failed to demonstrate that the inclusion of the MSA costs in revenue requirement would result in just and reasonable rates.
The AUC concluded that on average, the MSA pricing was 10 percent too high as a consequence of the sourcing strategy chosen and the tender/bid process employed.
Rate-Setting – Implementation of Any Adjustment to IT Rates for Cost of Service and Distribution Utilities
The AUC directed the ATCO Utilities to show the disallowances calculations and clearly show the directed IT disallowance on an annual basis by capital, indirect capital, and operation and maintenance in the applicable rebasing and K-bar schedules in their next annual Performance Based Regulation (“PBR”) filings. The distribution utilities should also demonstrate that the first year disallowance in 2015 does not affect the determination of the lowest operation and maintenance cost year and, if it does, they should adjust the notional 2017 revenue requirement accordingly to reflect a different lowest operation and maintenance cost year.
Decision and Order
The AUC directed the ATCO Utilities to file compliance filings to this decision reflecting the impact of this decision as part of their next annual PBR filings.
