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John Tizard: Buyer, be aware when outsourcing – check bidders’ corporate health

Tuesday October 11th, 2016

Over the last year or so, and most recently in the last few weeks, there has been a litany of major UK outsourcing companies announcing profit warnings and facing major challenges to their business models.

John Tizard

Serco, G4S and now Mitie and Capita have hit the headlines for reasons that they would not have chosen. These companies and others are very significant providers of public services. They have contracts across local and central government, the NHS and the police and other parts of the public sector. For a couple of decades these businesses have grown through the expansion of public service outsourcing. Some of them also have substantial non-public sector contracts too.

The public sector has often looked to the public service industry outsourcers as a means of improving service quality, ensuring service resilience and reducing costs in order to save expenditure. The effectiveness of such outsourcing has been mixed. There have been some significant successes and some very high-profile failures. Sometimes the latter have been caused by both poor provider performance and poor public sector procurement and contract management; and often there has been a combination of provider and client failure. Often in pursuit of cost savings public sector clients have sought impossibly low cost solutions which have proven unsustainable for contractors and reduced service quality to unacceptable levels. If contractors cannot make a reasonable profit margin they are less likely to deliver quality services. If the public sector sets unrealistic and/or unaffordable output targets there is an inbuilt flaw to the contracted services. Unfortunately there are too many examples of business providers bidding for and winning contracts which they should have known were undeliverable and/or unstainable, and consequently they should not have bid.

Such acts by either the public sector or an outsourcer are irresponsible and do not serve the public interest.

I have long argued that there should be an evidence-based review of public service outsourcing to examine its effectiveness and its impact; the conditions when it has been most effective and when it has not been; the competitiveness of the supply side of the market; and a wider economic and social evaluation of its impact on local economies, workforces and society. Such an enquiry or review is even more apposite now that major public service outsourcing companies are experiencing serious challenges to their business models.

When the banking crisis hit its peak in 2008 the view was taken that the major banks were too big to be allowed to fail. Given the current level of public service outsourcing and the apparent dominance of a few companies could the same now be argued for these companies? If so what are the economic and financial consequences, especially if one or more of them were to collapse or at least fail to deliver critical services? Any review or enquiry should address this key question service by service and identify in aggregate the level of dependency of the public sector on a handful of companies; and evaluate the consequential service, financial and political risks of such market conditions.

Of course now as at any time there will be public sector leaders and managers considering letting new contracts or renewing existing ones. Ensuring that they are procuring prudently means more than carefully considering their contracting expectations and specifications but also ensuring that they – or their advisers – undertake comprehensive due diligence of the corporate health of potential bidders. Companies that are facing corporate challenges may seek to maximise short-term profits from their public service and other contracts. This can often be at the expense of service quality. Public sector contracting bodies need to be aware of this and wherever possible avoid such possibilities.

For large-scale contracts only those companies that can demonstrate that they match pre-procurement set criteria demonstrating their health should be allowed to bid. Such an approach could be co-ordinated with shared information being made available across the public sector by the Crown Commercial Service or similar body. And it goes without saying that such an approach should be proportionate and not used to exclude smaller companies, ‘start-ups’, social enterprises and charities from bidding where this is appropriate.

This due diligence, in my view, should include as a minimum:

  • the financial viability of the company
  • the level of capitalisation
  • the diversity of the customer base and the benefits and risks associated with the range identified
  • known major financial risks and the plans to manage and mitigate these risks
  • ownership structures and the expectation of major shareholders and owners in terms of appetite for risk, returns on their investment – both the level and timescale, and the likelihood that a company could be sold or change ownership during the lifetime of contracts
  • track record on delivery of contracted operational and financial performance

Of course, some public sector contracting bodies would also wish to test bidders’ employment practices, remuneration policies/practices and tax records. Some may wish to test a host of additional and specific criteria and they will all want to test and evaluate actual bids for their operational, technical and financial viability. Standard practice should be to consider the wider commercial health of the businesses too.

The onus to do this has to be on the procuring body but there has to be a requirement on companies to co-operate as there should perhaps be on their external auditors. Clearly companies in return should expect some protection of commercially confidential and sensitive information. However, the over-riding consideration has to be the public interest when public services and public money is involved.

When the public sector procures public service contracts it has to be fully aware of all aspects of the market and the sellers and providers within it. The public sector should never buy on the basis of hope or what the bidder’s sales pitch says but on evidence and long-term assurance. Failure to do so will lead to poorer service quality and higher costs for the public sector. It would be a betrayal of the public interest.

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