By Joshua.Chambers

28 Feb 2014

Even after years of public sector outsourcing, many departments still struggle to attract a wide range of bidders for new contracts. Joshua Chambers explores how government could create more diverse and thriving markets

The preparations for the working day start early at London’s Billingsgate Market. At dawn, fresh cod from Cornwall and salmon from Scotland will roll in on lorries from the coast, while chilled eels will come from as far away as New Zealand.

The atmosphere is one of frenzied activity: back-breaking preparations are required to get the products ready for sale. Small family firms rub shoulders with the bigger players, and a prevailing mood of chirpy industriousness fills the cavernous hall. The choice is vast and standards are high, with regular inspections ensuring the produce is well-prepared and top quality.

It’s this model that governments across the world are trying to copy when seeking suppliers to deliver public services to their citizens. Thriving markets offer far better quality and prices than single suppliers, whether you’re buying fish or care services. Indeed, this government seems to believe that introducing competition will always improve public services: just last month, Cabinet Office minister Francis Maude wrote an open letter to the Confederation of British Industry arguing that “public services are too important to too many people to be allowed to be the monopoly of the public sector.”

Meanwhile, in a recent speech entitled ‘The Treasury View’, HMT’s permanent secretary Sir Nicholas Macpherson said that his department favours the creation of markets because “efficient product markets create the competitive pressures to help keep prices down, encourage firms to innovate and to minimise their costs of production”.

Recipe for success

Billingsgate Market has existed since the 16th century. What’s required to produce as robust a market in public services? Tom Gash, programme director at the Institute for Government, last year led a project looking at this very question – and his team set out five key characteristics of a successful public contractor market.

First, new providers must be able to enter the market and grow, he says, helping to establish the second factor: providers competing actively, and in desirable ways – for example, by improving efficiency rather than cutting quality. Third, it’s vital that poorly-performing providers can exit the market without excessive disruption to service users; this is often trickier in the public than the private sector, as many public services work with the poor, sick and vulnerable. The fourth criteria, Gash says, is that service users are able and motivated to make informed choices between providers. And the fifth is a constant across public services, marketised or otherwise: levels of funding must be appropriate to achieve government’s objectives.

In practice, the British government hasn’t always been able to achieve all these; in many of its markets, a few big suppliers dominate the landscape. And this isn’t because they always deliver a sterling service – as the Ministry of Justice’s experience with electronic monitoring suppliers G4S and Serco reveals. The MoJ believes the firms were “charging the department for monitoring fees for months or years after electronic monitoring activity had ceased; over similar timescales where electronic monitoring never occurred; and multiple times for the same individual if that person was subject to more than one electronic monitoring order concurrently,” according to last year’s National Audit Office report.

Due to the size of these particular contracts, only one other government supplier – Capita – was able to take over the work when the government took it back from G4S and Serco. While Capita may provide a perfectly creditable service, electronic monitoring clearly isn’t currently displaying the “efficient market of competitive pressures” that Macpherson aspires to create. Gash believes that problems occurred in this market because the five criteria weren’t all in order: due to the large size of the contracts, there were only two providers in the market. “In the next round of contracting, who’s going to know how to provide this service and be able to challenge Capita?” he asks.

Splitting markets up

One government commissioning model that’s tried to increase competition and involve smaller companies is the Work Programme, run by the Department for Work and Pensions (DWP). This packaged up its contracts into regions, attaching conditions to ensure that prime contractors subcontracted some work to smaller businesses and charities.

Rob Wormald was the department’s head of market development as the Work Programme was being created. He says the DWP was able to learn from its previous attempts to build markets in welfare to work delivery, and is proud to have attracted big players – such as G4S and Serco – whilst retaining its existing suppliers and encouraging a raft of small charities and social enterprises to become subcontractors. Due to the long-term nature of the contracts, the National Audit Office’s most recent report said, it’s still too early to judge the success of the market – but Wormald thinks it’s notable that none of the big suppliers have decided to leave, despite the difficult economic conditions and the tough payment-by-results model in place.

It’s also possible to create greater competition when contracts are run by local authorities, rather than managing them from the centre: council contracts tend to be smaller, making them more suited to charities and SMEs, and councils often have existing links to local providers. This is the model used in the social care market, a particularly strong market with a large number of providers; and Michael Coughlin, Local Government Association executive director, recently pointed to the provision of youth services as another well-functioning public service market. While there are variations in quality, the best markets – such as in Oldham – show how local commissioners can develop services, he said. Meanwhile, the Australian welfare market also uses a local approach, and Gash says it’s believed to be fairly effective.

Key preparations

What should a government department do to build a successful market? The National Audit Office has published a guide containing the key principles for achieving value for money when delivering public services through markets (see box below).

Its first consideration is ensuring there are “rules of engagement” for suppliers, ensuring good behaviour. The NAO advises that commissioners don’t just rely on case law, but put in place a set of their own guidelines and financial penalties to regulate the behaviour of those in the market. Guidelines and regulations can include minimum standards or rules governing equity of access to services, ensuring that suppliers don’t discriminate in who they serve in order to drive up their success rates. Financial incentives can include higher payments for serving users who are more difficult – and therefore more expensive – to help.

The Office of Fair Trading (OfT) has supplemented this advice with its own guidance for civil servants just starting to develop a market. It says that civil servants should ensure “clarity and consistency in the management of competition”; “consider the objectives and roles of regulators”; “use contract design to help the development of competition”; “develop ways to evaluate the effectiveness of market mechanisms”; “develop ways of addressing provider failure” and “be realistic about how stakeholders will respond.”

Tackling barriers to entry

One of the biggest problems in any market is the emergence of barriers to entry, and plenty of these can arise when developing public service markets. Peter Smith is former president of the Chartered Institute of Procurement and Supply, and runs a procurement consultancy. The first barrier to entry, he says, is that public sector procurement tends to be risk-averse: “Not unreasonably, it places a high weighting on past experience and whether the supplier has done it before.”

While there have been some efforts to reduce the weighting given to experience, Smith believes “there’s inevitably an intrinsic bias – if one supplier has done it ten times, why would commissioners take the risk with someone who’s never done it?” So the system is still skewed in favour of those with more experience of delivery – though a new EU directive does at least allow departments to take into consideration a history of poor delivery, ensuring that civil servants aren’t required to favour those with a bad track record over those with no track record at all.

Another problem is of judgements made on the basis of the size and financial specifications of a bidder, Smith says. Suppliers are required to have a significant amount of capital in the bank to take on many contracts, ruling out smaller suppliers. The problem is declining as government seeks to package up some of its contracts in smaller pieces, but the bigger national contracts are still likely to go to the big suppliers who can afford the upfront investment.

A third problem, Smith notes, is the complexity of bidding requirements. There can be hundreds of pages of forms to fill in, he says, and some companies will better understand how to complete them. For example, a form may ask if they’ve got a certain international quality standard (ISO 9002) for some of their processes. Smith says he’d advise a bigger supplier that doesn’t comply to say: “No, we don’t, but we have our own internal quality processes which we believe are equivalent” – an answer he says government will never check. However, inexperienced suppliers tend to answer “no”, and so will be eliminated from the tender.

Data storage can be another problem; understandably, government departments want citizen data to be stored very securely – and Smith says smaller companies can struggle with the expense of upgrading their IT to make it compliant.

Conflicting aims

These last two challenges illustrate one problem with favouring smaller suppliers: the costs of winning and preparing for public sector work can lumber inexperienced bidders with extra costs, whilst smaller organisations already produce fewer economies of scale than their bigger rivals.

Meanwhile, many charities find that shortages of financial reserves and commercial skills make taking on a payment-by-result contract daunting. Research published this month by London South Bank University and the Institute for Government found that over 80% of charities are worried about the financial risks involved in PbR, with 80% concerned about their chances of recovering their costs and 78% worried they won’t be able to raise the capital required.

The report also raises concerns that providers’ fears about covering their costs prevent them from taking innovative approaches to delivery – challenging the idea that PbR supports innovative delivery by paying providers to produce a result, rather than to follow a set process. At an event held to promote the report last week, Dr Henry Kippin from London South Bank University suggested that payment by results contracts make suppliers risk-averse, asking: “Is it a market if all suppliers are taking the least risky option?”

In response to this report, Helen Stephenson, head of the government’s Office for Civil Society, pointed to Social Impact Bonds as a way to minimise the risk for smaller providers. “Social Impact Bonds de-risk the contracts for providers,” she said: investors fund their efforts, and take the hit if results aren’t achieved. However, the social investment market is currently small – albeit growing. Stephenson also stressed the importance of pre-market engagement with a whole range of suppliers, to help them prepare to enter the market and jump through the necessary hurdles.

Subcontracting struggles

The Work Programme has sought to help smaller providers by specifying that larger suppliers must subcontract work to a range of organisations, including charities and social enterprises. However, some subcontractors have complained that they are getting squeezed by the bigger players – who hoover up the majority of the profits, and pass little down the food chain. It’s very difficult to stop this, Wormald says, because the legal contract is with the prime contractors – not the subcontractors.

The Work Programme put some basic principles in place, he says, and also encouraged a whistleblower system whereby charities could complain. Small suppliers have proved very wary of blowing the whistle publicly, he says, because they fear they’ll be penalised by the main contractor when contracts come up for renegotiation. So the DWP now accepts anonymous complaints, and then communicates the general point to all of its contractors in the hope that those who are misbehaving will stop, Wormald says.

Gash notes that it is possible to specify in contracts with large providers that they can’t pass on the risk to smaller suppliers, and to limit the amount of work they may subcontract on a payment by results basis. However, “it’s tricky because it constrains the major suppliers. They would say: ‘We’re taking risks on this, and we need to incentivise the social sector providers, so they should take some of the risk’.”

Regardless of these problems, public service markets aren’t going away – indeed, they’re growing in popularity across the world. The trend started in Anglo-Saxon countries, Gash says, notably Australia, New Zealand, the United States and Canada. But nowadays public service markets are also spreading into countries that wouldn’t traditionally be associated with them. The social democracies of Scandinavia have started to use them for a range of public services, and Germany is embracing them too.

As these countries do so, there’ll be a greater international wealth of experience to draw on. But designing and managing a market is always going to be a slippery issue. Certainly, creating a public services market with a chance of matching the longevity of Billingsgate – 500 years and counting – will require strong regulatory oversight, well-built contract models, intelligent and discriminating commissioners, and a diverse range of providers.

Given these factors, there’s a good chance that outsourcing can drive down the costs of delivering services. Ultimately, though, all markets should be measured on the quality of goods they provide. It’s no good talking about the price of fish, if it’s all rotten.

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