Cabinet Office minister Francis Maude has publicly stated that he wants to reduce the profit margins of suppliers of government-contracted public services. To that end, he has recently completed a ‘re-negotiation’ of contracts with the government’s major suppliers and claims to have achieved his goal.
How will he know if he has? And how will the public know? It is one thing to reduce the level of expenditure on a contract, but it is quite another to secure lower profit margins.
The supplier may be able to reduce costs and thus the price paid by government by paying its supply chain lower or by lowering the standard of service provided (with or without the client’s consent) or through redesigning processes. Or the contractor may seek to reduce labour costs through employing fewer people and/or diminishing terms and conditions.
If the government’s goal is simply to pay lower contract prices, it may not be too worried about how these are achieved. However, when Serco temporarily suggested that it would pass its lower revenues onto its supply chain, ministers cried ‘foul’ and demanded that Serco bear the pain of the lower payments.
It’s a delicate balancing act. Get it wrong, and the government will fail to deliver the necessary savings.
If government wishes to secure lower profit margins, it needs to better understand the potential implications. If a company can secure more attractive commercial deals in other markets – be they in the UK or overseas – it may decide to exit the UK public sector market. Lower margins may prove a disincentive to investment in new systems, people development and service redesign with the outcome that government fails to achieve sustainable productivity improvements.
Lower margins may also lead to more reliable and experienced companies withdrawing from the public sector markets to be replaced by less reliable and inexperienced providers. In some circumstances this may lead to issues about service quality and potentially to having to re-let or re-negotiate contracts resulting in higher prices and more client-side costs.
Assuming the government does want to squeeze profit margins, it really needs to know what these actually are. Many public sector contracts are currently subject to some form of ‘open book’ accounting whereby the contractor agrees to share detailed accounts for the specific contract with its client. Unlike joint venture and public private partnership contracts, there are no standard or specific protocols or accounting standards for many of these arrangements.
So here’s the way out of the conundrum. I contend that given the government and public’s desire for greater transparency and popular audit of public expenditure, the time has come for a national agreement between the supplier industry, government and the wider public sector and accounting professions for an agreed standard protocol for ‘open book’ accounting.
This should include: agreement on what will be included in these accounts and how; what the criteria will be for applying any confidentiality conditions (for example as a re-bid period approached) although the assumption should be that all accounts will be available to the client; external independent audit arrangements and access for client internal auditors; disclosure of contract terms; and disclosure of operational performance and any consequential contractual penalties and/or bonuses.
If government is truly serious about safeguarding the public purse, it should also consider applying profit-sharing arrangements in such contracts. Each contract should thus agree what will be an expected profit margin for a given set of outcomes or outputs. If the supplier is able to exceed this threshold, there should be an agreed sharing of the extra profit with the client to an agreed formula.
This has the advantage of incentivising both client and provider to seek to increase productivity and efficiency, while acknowledging that often, the supplier will be limited in what it can achieve given its reliance on actions by the client to maximise benefits.
Such arrangements should be subject to parliamentary select committee and, where appropriate, local government scrutiny committee enquiry.
It may seem radical, but I contend that after some honest consideration, it is the case that a profit-share process – provided that it has safeguards to protect service quality, workforce matters and wider public interest considerations, and provided that there is genuine goodwill on both sides – can actually be mutually advantageous for both private and public sector. And actually, it’s how many private-private (or B2B) supplier relationships already operate.
The coalition government says it is radical – so ‘be’ radical, and aim for the bigger prize
The government has an opportunity to ‘transform’ public service procurement and contracting by adopting the kinds of approaches I have outlined above, rather than adopting an over-simplistic race of driving down to the lowest price for every contract. Experience tells us that this bargain basement shopping leads to poorer quality and often adverse implications for staff.
There is no long-term public benefit in contracting regimes that deter competitive supplier engagement – and this is what the current approach by the government is risking. There is an alternative that will deliver far higher returns, as well as a ‘win-win’ for both sides, but it will require political boldness supported by commercial acumen to get there.
John Tizard is director of the Centre for Public Service Partnerships (CPSP@LGIU)
