Global outsourcing giant Serco has claimed improved commercial skills in government contributed to the fall out fellow outsourcing firm Carillion as companies accepted contract terms they would not previously have agreed to.
Company chief executive Rupert Soames has called for a new era of transparency and fair-dealing from the government following Carillion’s collapse.
He made the request as part of the firm’s full-year results for 2017, which revealed the business made an underlying trading profit of £69.8m in the year to December 31, down £12.3m on the previous year.
Soames – who is the brother of veteran Conservative MP Nicholas Soames and a grandson of Winston Churchill – said the UK outsourcing market had been “thrown into turmoil” by Carillion’s collapse, and that there was a “very real risk” that the UK government would become “more than normally cautious in dealing with its suppliers”.
The UK accounts for around 40% of Serco’s global revenue – which was £2.95bn last year – but the business has had a turbulent relationship with the government in recent years. In 2013, it was accused of overcharging the Ministry of Justice for the electronic monitoring of offenders, and it has also shouldered significant losses on its "COMPASS" contract with the Home Office which provides accommodation for asylum seekers.
Soames said Carillion’s collapse stood as a reminder that “a significant number of businesses supplying government services in the UK have suffered very large losses” and that all was “not right” in the market for government services in the UK, while the situation could be further complicated if Brexit resulted in higher labour costs.
He claimed that around 2010, the “balance of power in the market began to turn”.
He said: “Government introduced austerity and sought to reduce expenditure, the supply of new work slowed, just as new competitors entered the market. At the same time, government started to hire poachers and made them its gamekeepers, and in recent years has improved its commercial and contracting capabilities beyond all recognition.
“Feeling compelled to deliver the growth they had promised, suppliers competed fiercely for a reducing pool of new business; prices fell, and a newly-savvy government discovered it had anxious suppliers prepared to accept risks and contract terms which in normal conditions they would not have agreed to.”
Soames said that sophisticated buying techniques had been imported from the private sector, with contracts for sensitive public services such as caring for asylum seekers were awarded to the lowest bidder by online auction.
This was to in part to blame for crisis in the outsourcing sector, according to Soames, which has also seen Interserve and Capita among the firms to have issued profit warnings.
“As margins fell, suppliers shrank their capital employed and increased their debt; some made assumptions in their accounting which had the effect of pulling forward reported profits; some used opaque financing facilities and extended the payment terms to their suppliers to make their reported cash flow more nearly match the stretched profits,” according to Soames.
“At the same time, falling interest rates and increasing longevity sent pension deficits soaring. So in a matter of a few years, a sector which previously had delivered healthy returns and supported well-capitalised balance sheets became under-capitalised, over-leveraged, and operationally and financially fragile. Given the amount of contractual risk suppliers were carrying, that fragility was going to show itself sooner or later.”
He said the company would be lobbying ministers on four grounds that it saw as crucial for repairing the outsourcing market.
Serco wants open-book accounting for public services so that the Cabinet Office and National Audit Office can see suppliers’ accounts for major contracts, with suppliers – both private and government owned – required to publish performance details every six months so their track record can be compared against stipulated requirements.
It is also calling for the introduction of an “orderly exit principle” for public contracts, which would allow both the government and contractors to walk away at pre-determined intervals in return for a fee. Soames said the measure would give either side the chance to get out of a deal that was not working out as intended – such as if the supplier was making greater than expected profits, government policy changed, or performance was unsatisfactory but within the bounds of the contract.
Serco’s other proposals are a corporate “living will” that suppliers of sensitive contracts would have to lodge with ministers, dictating how a services wold be provided if the agreed arrangement could not continue, and a “fairness principle” under which the government would agree not to “impose punitive or unfair terms and conditions or transfer unmanageable state risk”.
There was an “urgent need” for the UK to rethink the relationship between the government and its suppliers, Soames said. “We believe an approach based on the four principles would serve to restore trust and common sense in the market; remove the risk of excessive profits or losses; and encourage a more vibrant and competitive market for government services, one in which Serco would be an enthusiastic participant."
He also raised concerns that outsourcing of public services was likely to be a hot topic at the next general election.
“There is a very real risk that this will make the UK government more than normally cautious in dealing with its suppliers,” he said.
“On the other hand, it may make them more inclined to deal with suppliers who have established a track record for strong delivery, prudent accounting and who have a robust balance sheet.”
Less prominently in Serco’s annual report, the company confirmed that it had bought a portfolio of UK health-management contracts from Carillion’s liquidators for a price that was £18m less than it agreed in December, prior to the firm’s collapse.
It said the portfolio, which has annual revenues of “approximately £90m” and 14 years left to run, had been picked up for £29.7m earlier this month, down from a price of £47.7m announced on December 13.
Carillion was put into involuntary liquidation on January 15.