Opportunity costs: who wins from the outsourcing revolution?

1 May 15

The public sector is spending far more than private firms on outsourced services, despite a very patchy history of delivery. What can be done to promote better outcomes, particularly in value for money?

Outsourcing image

It was part of Margaret Thatcher’s revolution in the 1980s, along with privatisation and getting on your bike, and has been gathering pace ever since. Outsourcing – employing private sector providers to deliver public services – is now so firmly entrenched that today the UK public sector makes greater use of outsourcing than the commercial world.

‘It shouldn’t matter if providers are from the state, private or voluntary sector – as long as they offer a great service,’ David Cameron proclaimed in 2011, launching his government’s Open public services white paper. ‘The old narrow, closed state monopoly is dead.’

The white paper, published in July 2011, redoubled the pledge to open up delivery of public services. And in the two years to July 2014, advisory firm Information Services Group says the total contract value of public sector outsourcing agreements was £51bn compared with £30bn for the private sector over the same period.

However, the past 30 years of increased outsourcing has by no means been an easy ride, and the outsourcing landscape is littered with casualties.

Among the starkest examples is the electronic tagging of offenders, contracted out by the Ministry of Justice to G4S and Serco, which an audit in 2013 discovered had led to overcharging that ran into millions of pounds. Another watershed was the abrupt exit earlier this year of Circle Holdings from the running of Hinchingbrooke Hospital in Cambridgeshire, after a damning Care Quality Commission report. For detractors of public sector outsourcing, the catalogue of cost-overruns, delays and mismanagement seems long.

On the other hand, the impetus driving new outsourcing deals remains strong. As austerity prompts further belt-tightening, the lure of short-term cost savings encourages toe-dipping across both central and local government, as Cameron’s ‘better services for less money’ mantra strikes a chord.

A greater reliance on hard evidence both for and against outsourcing would help, argues Quentin Maxwell-Jackson, an independent consultant and former KPMG partner who has advised on numerous outsourcing projects in the UK. He is the author of a report by the independent, liberal think-tank CentreForum, which set out to unearth the common factors shaping success and failure of both outsourced and in-house service delivery.

‘Too often in the past the decision to outsource or retain services in-house was taken for ideological reasons – on the basis of “public bad; private good” or vice versa,’ Maxwell-Jackson says. ‘That kind of prejudice has led to numerous bad decisions which have cost the taxpayer billions.’

He believes a disproportionate focus on failure glosses over many examples of public sector provision trumping the private sector, such as Directly Operated Railways, which until recently ran the East Coast Mainline after National Express gave up the franchise in 2009. Or, on a smaller scale, street cleaning in the London Borough of Southwark, which improved after the council brought the service back into public ownership.

However, both proponents and opponents of public sector outsourcing agree that comprehensive, evidence-based analysis of the success or otherwise of projects is lacking.

‘There needs to be a much better understanding of what is actually going to deliver the best service, case by case. But unfortunately our research shows that in public services the same mistakes get made over and over again,’ Maxwell-Jackson warns.

In particular, he criticises inadequate metrics on performance, frequently compounded by the absence of a clear output-based specification. ‘Often projects are not adequately defined and it isn’t clear what success means. It’s about having good information and knowing how to measure and manage it,’ Maxwell-Jackson says.

A dearth of procurement skills across the public sector, combined with poor risk assessment, are at the root of many problems, other examples show. Transport for London’s 30-year PPP contract for infrastructure modernisation with Metronet is a case in point.

Metronet began work in 2003. By 2007 the company had entered administration, resulting in a loss to the taxpayer of somewhere between £170m and £410m, according to a National Audit Office report. In addition the Department for Transport had to make a grant payment of £1.7bn to help purchase Metronet’s debt.

Kerry Hallard, chief executive of the National Outsourcing Association, which represents both buyers and suppliers of outsourcing services, notes that appropriate procurement skills are also a big factor. ‘We have been lobbying government to break down deals into smaller chunks. However, it’s disappointing that we’re still not seeing the right skills development on the part of local and central government that the industry needs,’ she says. ‘There aren’t enough skills in the public sector to manage single supplier contracts, let alone multi-source arrangements. A lot of failures are due to clients not being able to manage the contract and governance not being good enough.’

The establishment of the Crown Commercial Service in 2014 was an attempt to address many procurement shortcomings. But even today, sharing of best practice is far from widespread and a lack of visibility surrounding contracts makes it impossible to work out how well providers are performing or call government to account for the way services are delivered, warns Tom Gash, director of research at independent think tank the Institute for Government (IfG).

A report on contract management by the Public Accounts Committee published in December 2014 in the wake of the tagging debacle called for open-book accounting and published contracts to become the norm. In an earlier report, the PAC noted that only one third of public contracts are currently agreed on an open-book basis and that even where increased transparency has been agreed, the facility is rarely exploited due to a lack of capability within the responsible departments.

In March, Cabinet Office minister Francis Maude committed to trialling a new transparency clause in contracts with private and voluntary sector suppliers, drawing on recommendations made by the IfG. They include publishing fees paid to government suppliers, details of main subcontracting arrangements and all-important performance data.

In the same month, CIPFA published proposals for implementing improved open-book contract management. In a briefing paper the organisation argued that the commissioning body and contractor should agree to share a proportion of both profits and losses, helping to mitigate the impact of unforeseen risks and costs. This arrangement would bring greater focus on value for money rather than lowest-cost bidding.
It is a model that has already been successfully pioneered within the UK construction industry, where a two-stage process has been adopted. In the first stage, a client invites outline bids with cost estimates. The client then works with shortlisted bidders to build full proposals, before finally awarding the contract at the end of the second stage.

CIPFA chief executive Rob Whiteman argues that open-book provisions should mitigate risk, while also improving efficiency and delivery. ‘This is far too important an area for government to just let slide, and it needs leadership and direction from those who decide where public resources are spent,’ he argues.

One of CIPFA’s concrete suggestions is that bids for major contracts should be independently audited. This measure would help to ensure that proposals are properly costed, helping to avoid the strain that results when a contractor bids low to secure work and then claws its way into profit afterwards.

The NOA’s Hallard says the open-book approach is not without issues. ‘There are a lot of very innovative pricing models emerging and for suppliers, that is part of your intellectual property,’ she argues. ‘If you publish how contracts are priced, you’re taking that competitive advantage away. The largest outsourcing providers aren’t in favour of open-book contracting but those wanting a bigger share of the public sector pie generally are.’

The aims of open-book contracting are laudable, says Nick Jones, UK director of cost & project management at construction services firm AECOM. But the approach has to be practical too, he warns. Without pragmatism, the quest for transparency can easily add cost and erode value.

‘It is essential that public sector senior management understands and buys into this, and has the governance and control to ensure it cascades down to procurement officers and is implemented in practice across the entire project cycle,’ he says. ‘This demands cultural change that many programmes can’t afford, either in time or in objective setting.’

Other objections are more philosophical. Campaign group We Own It describes the current outsourcing process as ‘old fashioned and undemocratic’ as public services are handed over to private providers under a veil of commercial confidentiality. ‘We don’t believe that private organisations are the best to run services because there’s a conflict of interest between profit makers and the need for a public services ethos,’ says We Own It’s founder and director, Cat Hobbs.

We Own It is calling for new laws on transparency and accountability in public service contracts – in particular a Public Service Users Bill that would give the public access to contracts and performance and financial data, and would put the public interest ahead of corporate interests by forcing the in-house option to be considered.

Before rising for the general election campaign, House of Commons Early Day Motion 438, in support of a Public Service Users Bill, had cross-party support and was signed by nearly 100 MPs. A poll conducted in February suggests there is public momentum behind the campaign; just over two-thirds of the 1,046 respondents believe the public should have a legal right to be consulted and given access to information on the outsourcing of public services.

While moves to increase transparency of contracts would make it easier for both providers and commissioners of services to be held to account, there is a certain convenience to the public sector being able to pass the buck to outsourcers for some of the less palatable or politically-sensitive decisions that are made on their behalf. ‘There is a degree of complicity,’ Gash says.

A focus on price has created a race to the bottom on wages, fuelling low pay and inequalities, say critics. Staff of privatised services are more likely to earn less, have insecure or temporary contracts and work longer hours than public service employees, according to research by the New Economics Foundation for the Trades Union Congress. And with Oxford Economics analysis suggesting that the public services industry employs 1.2 million people (indirectly it supports more than 2.3 million jobs) the wider social impact of low pay across the sector is not to be ignored.

‘Low pay has a huge social impact, necessitating in-work benefits which taxpayers must fund, and making it impossible for large sections of the workforce to prepare financially for their old-age and retirement. This also means we are storing up further costs for future taxpayers,’ says Peter Holbrook, chief executive of Social Enterprise UK, the national body for not-for-profit businesses.

Given that 80% of the cost of a contract is people, low staff morale and poor working conditions inevitably have an impact on service quality. The New Economics Foundation report for the TUC found evidence of a higher incidence of hospital infections after contracting-out of cleaning services to private companies, while private prisons have held a higher percentage of their prisoners in overcrowded accommodation than public sector prisons every year for the past 15 years.

Meanwhile, a trend towards complex and very large -scale contracts has reduced the competitive market to a handful of providers capable of bidding for such deals. Even at a local level, years of purchasing services from the lowest bidder on price has left authorities with little real choice over who they can buy services from. The IfG and CentreForum both say breaking down large, complex services into smaller, more manageable packages of work would help to reduce the risk of failure.

There is some evidence that the trend towards outsourcing may be, if not reversing, then at least slowing. ‘With the traditional model of outsourcing, there was an assumption you could improve quality and reduce costs. But the public sector is far more efficient than it used to be so the scope to reduce costs isn’t there in the way it was,’ says John Tizard, an independent strategic advisor and commentator on public policy and public services.

Tizard also believes spending cuts are forcing local authority leaders to question whether they can justify the time needed to run a procurement process properly. ‘There’s also a bit of a backlash from high-profile cases that make it a bit more challenging politically,’ he adds.

While experts say it’s essential to see the bigger picture, balancing the long-term needs of an outsourcing contract with a short-term political vision, often spanning only as far as the next election, is a hard nut to crack, exacerbated by cuts to a limited pool of specialists with the commercial capacity, procurement expertise and specialist skills to manage outsourced contracts.

‘You have to allow the outsourcer to invest and re-engineer the provision of longer term projects where cost savings come over the long term through new ways of working and economies of scale,’ Tizard says. ‘We need to look at new models that provide a more realistic transfer of risk.’

Matt Dykes, senior policy officer for public services at the TUC, agrees that each individual case for outsourcing should be made not just on the business case but also a public interest case based on consultation with relevant stakeholders, underpinned by transparency ‘from the way we’re commissioning it and award criteria to details about the company that has won including its tax status’.

The Public Services (Social Value) Act, which came into force in January 2013, gives councils and central government scope to take into account a broader range of factors than cost and quality, including the social and economic value in the delivery of contracts. But Holbrook says the bigger picture is still lacking in many cases.

For Guy Clifton, head of the local government advisory team at Grant Thornton, a culture that embraces entrepreneurial skills, good leadership, an appetite for risk and a desire to collaborate with suppliers is critical to outsourcing success. ‘Culture and behavioural change is more than a nice to have, it’s critical. But too many people are fighting fire to think about it, especially at a time of austerity.’