Time for an outsourcing wake-up call

20 Mar 15

Serco’s losses should be a wake-up call for both outsourcers and politicians. We need a review of the impact of and conditions for successful public sector outsourcing.

Given events of the last year or so, it was perhaps no shock that Serco announced losses for last year’s trading. What was surprising was both the scale of those ‘record’ losses, the statement from chief executive Rupert Soames that the company was continuing to make losses on a number of public sector contracts and his suggestion that in part this was the fault of the public sector.

Serco has reported an operating loss of £1.3bn compared to a profit of £236m last year. £1.3bn represents many years’ profits. The company has also reported the loss of goodwill and exceptional write-offs, and intends to press ahead with a £555m rights issue.

This is not good news for Serco shareholders – and it might prove not to be good news for its employees either. The implications for its many public sector and business sector clients are that it could also be bad news for them too if the company seeks to recover some of these losses at the expense of quality – although I should note that there is no evidence that Serco would seek to do this, and any such behaviour could only further damage the company’s reputation.

The Serco story (which now includes the infamous Ministry of Justice tagging contract) undoubtedly has the potential to damage the wider public outsourcing industry. It is most certainly bound to undermine the public’s and public sector confidence in this industry. And it could reduce investors’ confidence too.

Until a few years ago, Serco was at the top of the public service outsourcers’ league table in the UK and internationally. It was regarded by many commentators and analysts as reliable, innovative and committed to (what, for the business sector was perceived as) a sound ethical approach. It was a sector leader in terms of reach, scope of services and activities, and number and value of contracts. However, over the last year or so, its reputation has disintegrated, and the knock-on effects mean that there is bound to be some collateral damage for its competitors and other businesses involved in contracted public service delivery.

Allegations of fraud, mis-reporting performance and significant operational under-performance are never going to do any company any good, especially those competing for public sector contracts. We can now see that the price can be very expensive for companies and shareholders, and for executives who lose their jobs and personal reputations.

However, the Serco statements last week should be a broader wake-up call for government and the wider public sector, as much as for outsourcers.

I believe that the public sector and politicians in particular should have five areas of immediate concern and questioning about all existing and future major public service contracts:

  • is the provider making a reasonable profit margin to incentivise and enable it to continue to sustain quality and to invest in improvement and innovation?
  • is performance reporting accurate, and is this being adequately monitored and independently audited?
  • is the provider’s business model sustainable?
  • do we understand and are we comfortable with the provider’s ownership structure, ethics, managerial capacity, and governance arrangements?
  • is the breadth of the provider’s business activities, either in geographical coverage and/or range of services, so great as to make it very difficult for the senior executives and board to have adequate oversight and control?

It is vital to ensure that future contracts with the business sector, and for that matter with the social and charitable sectors, allow the provider to make a reasonable return on investment and profit – lest the temptation to cut corners and ethical failures prevail. To do so requires:

  • setting profit margin targets and caps, including any resulting from ‘margin on margin’ gains from internal company trading in the original contract, whilst allowing companies to make a ‘reasonable’ return
  • possibly introducing profit sharing arrangements
  • auditable open book accounting to agreed accountancy standards and making these publicly available
  • requiring providers to report regularly to the client on wider company performance and how this could impact on the contracted service

Given austerity and pressures on public spending, contracting should not be driven simply by lowest price procurement – which long term is a route to poorer quality and poorer outcomes. This means ensuring that ‘very low bids’ are deeply scrutinised, especially if they are a long way cheaper than other bids. Like it or not, the reality is that buying cheap often leads to higher costs in the long term – and unintended consequences.

If and when competition is to be used, there must be a competitive supply side comprised of quality competent providers – too few bidders and/or a bunch of second rate bidders are not acceptable or sensible when competition tendering is adopted.

This all requires public sector clients to talk to potential bidders, and most specifically to understand their commercial requirements before commencing procurement. It also requires contracts, which allow both the provider and the client to seek change control to meet new and non-anticipated circumstances, but in ways that protect the public sector ahead of the provider given the need to ensure value for money.

Procurement needs to be based on a sophisticated commercial competence including excellent due diligence on a bidders’ track record and wider company pressures (a problem in another part of a company’s business could adversely impact on the contracted service). Above all public sector clients wishing to adopt the approaches described in this article will require very sophisticated commercial understanding and skill available to the public sector.

More fundamentally, the events of the last year, including the Serco announcement on its losses, should remind the public sector (central government and beyond), including political and executive leaders of the dangers of ideological excursions into outsourcing or an assumed ‘default’ to competitive tendering for public services. If the biggest and previously most successful companies cannot sustain reliability and financial stability, or mis-price their bids, then what is the future for the wider outsourcing industry and outsourcing?

Does the requirement to meet what are often almost insatiable demands for growth in profits and dividends from shareholders – compounded by the effect of half year or even quarterly reporting – create a tension between long-term commitment to public service outcomes and short-term shareholder expectations?

The public sector knows and employs other service delivery models – in-house provision, shared services, co-production with citizens and communities, and collaboration with the social and charity sectors. There is no logical reason why these should not be the default or valid alternative options rather than outsourcing – although the approach may be different for different organisations and for different services.

When a public sector agency decides its preference for outsourcing for a specific service, I believe that it should statutorily be required to publish and consult on the business case, including anticipated profit levels for any provider, and the proposed arrangements for disclosure and accountability for operational and financial performance.

If the Serco losses are a wake-up call for the public sector, it is even more a wake-up call for the outsourcers. Those that learn the lessons will have a chance to survive (and achieve reasonable and transparent profits), and those that don’t will end up being punished – both by government and the markets.

Providers must accept that the public sector is not bound to offer contracts or opportunities to bid; and that contracts should deliver public value ahead of profits. And if they do outsource, public sector leaders must accept that providers will need commercially viable contracts – else there will be no bidders

Serco is unlikely to be the last company to have problems arising from public service outsourcing. For their part, the public is entitled to have confidence that public services are reliable, of the right quality, sustainable and ethical. And there must also be an appreciation that if there is outsourcing, then providers will need to make a profit if they meet their contractual requirements. It follows that if there are concerns about any profit or surplus being made from public services, then quite simply outsourcing should not be pursued. I suggest that what is now needed is a better understanding of outsourcing, the role of profit in public service provision, and how the sectors can work together, transparently, given their different dynamics, cultures and time horizons.

After decades of public service outsourcing there is no comprehensive and independently trustworthy evidence of its impact. There are many questions requiring answers, in particular, what conditions have led to outsourcing adding public value, and which have not. The next government should commission a comprehensive, evidence-based review of the impact of and conditions for successful public sector outsourcing and the alternatives.

Public service outsourcing is most unlikely ever to disappear in its entirety but it scale of use may change as might the circumstances where and how it is applied. Therefore, the events of the last year, including Serco’s recent announcements, make the review suggested above absolutely essential – and should wake up providers and government alike.

  • John Tizard
    John Tizard is an independent strategic adviser and commentator on public policy and public services. He works with a range of public, private, third, union and academic organisations. He now holds several non-executive, trustee and chair roles in the VCS and arts sectors. He was a senior executive both at Capita and Scope, and is a former joint council leader

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