2. Operation and management of the contract (2014-2018)
2.1 Natural Retreats commenced the operation of the Cairngorm mountain resort in 2014. They faced challenging operating conditions in several of the subsequent years, including low snow levels. These resulted in the adoption of a new business plan, which was ultimately approved by the HIE board in 2017.
2.2 Throughout the contract period, which covered June 2014 to November 2018, quarterly performance meetings took place between HIE and CML which reviewed financial performance as well as service level key performance indicators. In addition to this, update reports were provided to the Chief Executive, Chair, HIE Board and Risk & Audit Committee as necessary, with key decisions taken and recorded as required. Regular operational meetings were also undertaken by HIE's property and infrastructure team as necessary. HIE worked alongside CML on stakeholder engagement plans to build relationships and try to address stakeholder concerns.
2.3 The management fees of Natural Retreats have attracted significant attention from stakeholders and the media in the aftermath of HIE bringing the management of Cairngorm back into the public sector. It should be noted that these fees formed only one part of the basis on which Natural Retreats' bid was evaluated and of the overall commercial package.
2.4 The maximum level of management fee was agreed during contract negotiations following expert advice from HIE's advisers [REDACTED] and was to be no more than 13.5% of turnover. This fee, paid by CML to the NAIL Group for services provided, covered mainly sales and marketing expertise but also central operational management, including finance and HR expertise. This was not a payment from HIE to the NAIL Group. It is normal practice that an operating company will be recharged for such services from the wider group where it does not have the internal capability. These costs should always be monitored in order to ensure transparency, that the costs are reasonable and that there is no profit leakage on these fees. To mitigate against this specific risk, the fee was based on turnover and above an agreed level a "ratchet" applied whereby HIE would share in any upside.
2.5 The fee percentage was benchmarked against the second ranking bidder and also against a proxy market benchmark based on 4* and 5* hotels. The advisers noted that there was limited ability to directly benchmark these fees due to the unique aspects of the Cairngorm operations including operation of the funicular. The fee was lower than the second ranking bidder's and the proxy market benchmark obtained. The financial analysis undertaken during the bid evaluation indicated where costs could be saved as a result of the management fee services supporting the conclusion that this was robustly considered as part of the procurement exercise. This was all deemed reasonable and accepted by HIE. That the Natural Retreats fee was lower than the second ranking bidder's supported these conclusions.
2.6 Across the contract period £1.9m was paid by CML in management fees to the NAIL group. On average across the years the contract operated this did not exceed the 13.5% threshold, and was on average below it, however in 2017 it did do so marginally when the management fee was 13.9%. This does not appear to have been challenged during the regular quarterly performance meetings between HIE and CML.
2.7 Overall there is little recorded evidence of monitoring or challenge of the management fee or of other overhead costs, particularly against the business's overall financial position. Within the quarterly monitoring reports the very first quarterly monitoring report included a breakdown of overheads, however in subsequent reports this information was reported as one cost line. This indicates that this level of analysis was possible but not pursued over the contract period.
2.8 HIE officials note that the management fee was not part of the contractual arrangements between themselves and CML as this was effectively an intra-group transaction for the services detailed in paragraph 2.4 above. As such it is noted there was limited leverage which HIE had to influence this.
2.9 Given the use of public assets by CML to undertake their business and to ensure value for money was being achieved it would be normal contract management practice to undertake some analysis and scrutiny of the overhead costs and management fee to gain assurance that these were being managed efficiently, allowing operating profits to be maximised. It would also have allowed HIE to assess if the level of management fee correlated with the level of service provision to CML by the wider group and provide an indicator of escalating cost if tracked over time.
2.10 The previous section notes the financial standing risk identified during procurement. It is not clear from our review that this was specifically addressed during the regular monitoring process. We would anticipate that ongoing monitoring incorporated a review of the operator's management accounts and balance sheet and seeking of ongoing assurances of the principal investor's continuing support of the business in light of the risks previously identified. It is also reasonable to expect that during the contract operations there should be ongoing monitoring of the guarantees and consideration of their fitness for purpose. We understand that this was not undertaken.
2.11 We have noted above that Natural Retreats adopted a new business plan in 2017. This was based on two years of experience of operations and resulted in a request to utilise the loan offered by HIE for alternative purposes including improvements in retail space and the development of an artificial ski slope and upgrading of the Ptarmigan restaurant building. HIE officials engaged with the operator in developing this plan, including a further assessment of the company's financial standing. The HIE board ultimately approved it in April 2017. It was considered that the new business plan and investment proposals remained in line with HIE's objective of generating economic benefit in the local area.
2.12 During the procurement process Natural Retreats advised that they planned to invest a total of £9.8m across the whole contract period, with £6.2m to be expected within the first four years. This included the £4.0m HIE loan agreed and therefore a further £2.2m from Natural Retreats. Our review of the relevant documents has identified that c£1.8m of investment in assets was made by Natural Retreats over the duration of the contract.
2.13 Progress was being made on investment plans, however it did take CML three years to produce the masterplan. Timescales for implementation were being impacted on by planning permission requirements and HIE officials advised that there was insufficient engagement between CML/Natural Retreats management with the planning authority and wider stakeholders.
2.14 Per contractual requirements, annual maintenance expenditure by CML was to be no less than £0.5m. Additionally, an asset replacement account was required to be established and funded by CML. From early in the operating period, compliance issues were identified by HIE and they have evidenced on-going dialogue in trying to resolve this position. HIE were in active discussion with CML and supported by their property advisers on how to ensure that CML's obligations were met in this regard.
2.15 At the outset of the contract it was agreed that HIE would complete legacy works of £1.7m. This was agreed with both parties during the final tender stage. This consisted of dilapidations of £0.9m and Ski lift enhancements of £0.8m.
2.16 Over the contract period, total investment of £3.4m was incurred by HIE. This included the £1.7m referred to above and also included £1.2m in the final months of the contract period following closure of the funicular and clear indications that CML were not in a position to continue operations as discussed further in the section below. This investment covered engineering works and the purchase of snow making equipment following wider sectoral engagement. The remaining £0.5m was incurred throughout the four year contract period.
2.17 HIE officials have stated that the investment they made over this period was not a contractual obligation on the part of CML/Natural Retreats. HIE continued to own the assets at Cairngorm Mountain and therefore some level of investment could reasonably be expected.
Key issues - operations
Were the monitoring arrangements put in place sufficient?
Response & mitigation
HIE officials have advised and evidenced that whilst relationships were challenging there was continuous engagement with CML.
Key decisions were routed through the appropriate governance structures, in particular, the approval of the revised CML Masterplan and change of use for the £4m loan.
There is limited evidence of sufficient scrutiny and challenge on the management fee and overheads across the contract period to gain assurance that these were appropriate and achieved value for money. Furthermore, there is limited evidence of ongoing review of the financial standing of the contractor and the guarantees obtained given the risks identified during procurement.
Perceived lack of private sector investment across the contract period
Response & mitigation
Slow progress was made on investment plans. This was further hindered by challenges arising from the planning and regulatory environment of the National Park. HIE officials developed stakeholder engagement plans to help advance investment plans but believed there was insufficient engagement on this by Natural Retreats.
There were compliance issues in relation to the £0.5m annual maintenance contract requirements and the asset replacement fund contributions and HIE were working alongside CML to resolve this.
In the first four years of the contract, CML did invest £1.8m although £6.2m was initially planned to have been completed, which included use of the £4m HIE loan (which we note was not drawn down).
Was it appropriate for HIE to continue to invest public monies over the contract period?
Response & mitigation
HIE incurred £3.4m of investment across the contract period with £1.7m of this agreed at the final tender stage as legacy works.
HIE continue to own the assets at Cairngorm Mountain and therefore some level of investment could be reasonably expected.