Outsourcing: where it has worked, and how to avoid being caught out

By David Donaldson

Thursday February 20, 2020

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Some services have benefited from outsourcing, while others have caused harm to vulnerable people. A UK study examines what factors make failure more likely, and how to avoid being caught out.

Outsourcing may be less fashionable in this age of Jeremy Corbyn and Bernie Sanders, but it has been a core part of government’s repertoire for long enough that it’s fairly clear what works.

Although a bugbear in some corners of politics, in reality outsourcing is widespread in countries like Australia, and often works well enough that it passes un-noticed.

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And yet there are also plenty of egregious examples of deals gone wrong, costing the taxpayer billions and even harming vulnerable people.

With the UK Labour party calling for outsourcing to be wound back in many areas, the London-based Institute for Government published a report last year looking at 11 cases of contracting out in the UK, ranging from those that saved money and improved services to the damaging.

“In areas where outsourcing has failed, bringing services back in-house could improve them,” argues the institute.

“But bringing swathes of services back into government hands by default risks throwing away the significant benefits that outsourcing can deliver.”

The think tank rates how well different services have fared under outsourcing by colour, ranging from green (positive) to red (negative):

  • Waste collection: green
  • Catering: green
  • Cleaning: green
  • Maintenance: green
  • Back office (HR and IT): green/amber
  • Prisons: green/amber
  • Health care (clinical services): amber
  • Employment services: amber
  • Adult social care: amber
  • Private financing of construction: amber/red
  • Probation: red

Green means there is consistent evidence of savings, quality improvements or wider benefits, including innovations, as a result of outsourcing or competition; amber means the evidence is mixed, with some studies showing no difference, others showing cost or quality improvements and others showing increased costs or lower performance or quality; red signifies consistent evidence of cost increases or lower performance or quality.

Outsourcing has worked particularly well in fields that are easy to contract for and deliver, such as waste or cleaning, argues the institute:

“When these services were first outsourced in the 1980s and 1990s, it delivered large savings, often around 20% of annual operating costs, mostly while maintaining levels of quality. Companies therefore achieved significant efficiencies, although some savings were driven by paying staff less.”

Over time, however, public services in these areas have become more efficient, and are now able to compete with the private sector, leading to some functions being brought back in to government in the UK.

This is because many efficiencies come through the threat of outsourcing, as opposed to the outsourcing itself. This is one of the ideas behind contestability. Many of the efficiencies of Victoria’s public transport system occurred in anticipation of it being contracted out in the 1990s, for example, making it difficult to say whether private operation is better than a well-run public system.

Many fields received mixed reviews. Interestingly, given its bad reputation in the United States, the institute says there have been some benefits in privatised prisons in the UK:

“Private prisons are cheaper to run and have introduced innovations, including in how staff treat prisoners. They perform better on some quality metrics and worse on others, but the introduction of competition has improved performance in public prisons.

“Outsourcing has provided extra capacity in the NHS [National Health Service] and, in some cases, improved the performance of public hospitals, but there is a lack of comparable data on cost and quality and some case studies show damaging failures.”

Outsourced IT services have often worked well, despite some high-profile failures, as agencies often started with low in-house capability and were able to buy in expertise from the private sector.

Private financing of construction projects has made them more expensive, without any obvious benefits. Opting for private financing is often driven by accounting rules which mean private debt is ‘off balance sheet’ for government, even though borrowing money is more expensive for the private sector.

But contracting out the management of probation has been a disaster, the report argues:

“Outsourcing has failed on every measure, harming ex-offenders trying to rebuild their lives. The heavy costs show why government should be cautious about extending outsourcing of front-line services and only do so when it is confident it will work.”

Outcomes were poor, with the number of re-offences per offender, and the number of prisoners recalled to prison for breaches, both increasing.

The market for such services had been poorly developed, with the ministry needing to encourage companies to bid, and many of those chosen having little experience in the field.

It was also difficult to measure success in probation. Formalistic indicators such as the completion of sentence plans were gamed by providers, while things like re-offending rates were partly outside the control of providers, as courts and police play a major role in determining these outcomes.

It appears not to have saved money, either. An audit 2019 concluded the contract had provided “poor value for money”.

Indeed, the age of great savings may have passed. Politicians often argue outsourcing can cut costs by 20-30% — as some efforts did in the 1980s and 1990s — but it seems unlikely this would be possible today. The benefits, where they do exist, tend to be more in the range of 5-10% in these days of much leaner government.

And while public versus private ownership receives plenty of attention in public debate, this is not the only determinant of performance — and can often be a relatively minor one. Management, funding and staff capacity all matter a great deal — in public transport, for example, a private or public operator will struggle to deliver punctual services if cabinet refuses to spend the money to build and maintain the infrastructure.

Success factors

The Institute for Government argues there are three particularly important factors in whether an outsourcing initiative will succeed:

  • The existence of a competitive market of high-quality suppliers, without which government opens itself to supplier opportunism and risks poor service performance;
  • The ease of measuring the value added by the provider, without which it is difficult to write and price contracts and monitor performance;
  • The service not being so integral to the nature of government as to make outsourcing inappropriate, for instance when a supplier has to make key policy decisions.

The think tank argues that where these conditions were not met, “government should avoid outsourcing unless it had a clear strategy to mitigate the risks that contracting out would create”.

Successful cases tended to meet these conditions.

“For example, successful IT contracts have drawn on a strong market of good suppliers and established robust governance metrics. Failures breached these conditions. In probation, there was no market and officials could not adequately define quality or measure performance. The decision to outsource was wrong.”

There were also four factors that came up repeatedly in failed initiatives, and which tended to be avoided in successful cases.

  1. Failing to engage early with the market, or to ensure there was a clear, mutual understanding of what was expected. This leads to cost over-runs and disputes during the life of the contract.
  2. An excessive focus on getting the lowest price, while ignoring service quality and other factors.
  3. Transferring major risks onto the private provider that they do not have control over and cannot manage. Such risks are never really transferred, as they will fall back on the government if they become too much for the contractor.
  4. Even if government secures a good agreement, poor contract management by government often undermines good outcomes.

Pursuing the lowest price to the exclusion of other factors has been a big issue in the UK in recent times — though it’s a problem with a very long history. It appeared to be a factor in the collapse of major outsourcing firm Carillion in 2018, by tempting Carillion into entering such cheap contracts that the company itself became unsustainable.

Another example was the contracting out of translation services for courts, which was done for such a low price that the provider couldn’t hire enough translators and ended up collapsing, in turn causing delays and other problems in the justice system.

Tom Gash, senior fellow at the institute, gave this advice at the IPAA national conference a few years ago:

“When someone says ‘I can take all these problems off your hands, you don’t need to worry about it anymore’, and you say ‘let’s try and do that and make it cheaper at the same time’, lots of things can go wrong.”

Outsourcing expert Gary Sturgess has argued some of these problems have increased as governments have become more aggressive in their approach, behaving in a highly transactional way when ongoing, complex services require personal relationships and institutional trust between the contracting parties:

“Government must formally acknowledge at the highest level that the procurement and contract management tools appropriate for buying ‘paperclips’ — highly commoditised, easily specified goods and services — are not appropriate for commissioning complex support services and front-line human services.”

Six questions to ask

An earlier Institute for Government report recommends governments ask a series of questions when contemplating whether to go down the outsourcing route.

A ‘yes’ answer to any of the following questions creates challenges for in-house management — but generates particularly acute risks when using contractual mechanisms. The think tank argues “that policy makers and commissioners should not introduce contractual mechanisms in these areas without putting in place a clear strategy for mitigating these risks.”

  1. Is it difficult to measure the value added by the provider? If a service lacks objective or quantifiable measures of the value added by the provider, it will be more difficult to price contracts and monitor performance.
  2. Are service outcomes highly dependent on the performance of other services? If services that depend on one another to achieve their outcomes are contracted out to competing organisations, it may be more difficult to incentivise and secure the necessary cooperation between providers.
  3. Does delivering the service require investment in highly specific assets? If a service requires investments in highly specialised physical or human resources, government may find it costly to attract providers and, over time, could be left vulnerable to an incumbent provider with excessive market power.
  4. Is the service characterised by high demand uncertainty? If demand for a service is not known in advance, or subject to unpredictable variation, government may find it costly to incentivise investments and/or may be left vulnerable to ‘hold-up’ situations.
  5. Is the service characterised by high policy uncertainty? If there are politically motivated changes in policy direction or service specification, the government may find it costly to renegotiate contracts.
  6. Is the service inherently governmental? If a service involves making key policy decisions, is central to government’s law and order capability, or intimately related to government’s duty to protect the public, contractual mechanisms are unlikely to be appropriate.

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