House of Commons - Public Administration

Select Committee on Public Administration Eleventh Report

6 LEVELLING THE PLAYING FIELD

"If the sector is so good, why are they not winning now?"[106]

Will Werry, Commissioning Joint Committee

89. An underlying theme in all of our discussions around the characteristics of the third sector's supposed distinctiveness was the importance of the commissioning process in determining whether those characteristics came out in practice when services were delivered. Indeed, inconsistency in commissioning practice proved to be one of the primary difficulties in assessing whether certain organisations had inherent strengths in their make-up. If a third sector organisation is not performing distinctively in providing a certain service, it is not always clear whether this is because there is nothing distinctive about the organisation, or because a poorly designed commissioning process stopped that organisation from playing to its distinctive strengths. Equally, where third sector organisations are providing a seemingly distinctive service, it is often unclear as to whether organisations from other sectors might, if commissioning practice were right, be capable of providing a similar service—possibly at a lower price.

90. The principal mechanism through which public service commissioners engage third sector organisations to deliver public services is competition for contracts. Although there is scope in some circumstances for public service contracts to be allocated without competition, those circumstances are severely limited. This is unlikely to change in practice due to EU regulations designed to ensure openness and fairness in procurement, as the Office of Government Commerce (OGC) explained to us:

107

91. Bad commissioning can prevent commissioners from buying the distinctive qualities they are looking for in the provision of a particular service. Many of the factors preventing the best outcomes for third sector providers were not sector-specific problems and did not require sector-specific solutions. Although some of the weaknesses in commissioning practice identified might in practice be particularly damaging to potential third sector providers, addressing these weaknesses would improve the commissioning process for all concerned—including, most importantly, the end user and the taxpayer.

92. Given the inquiry's focus on the third sector, however, much of our evidence focused on how the Government could use the commissioning process to get the best out of the third sector in particular, with third sector-specific solutions. In particular, we heard more than once that simply improving commissioning practices would not be enough for the State to reap the benefits of third sector participation in service provision. According to this argument, third sector organisations face particular disadvantages, whether born of commissioning practice or of inherent characteristics, which mean that they will need special treatment from the State for their strengths to be brought out in service delivery. Proponents of this view often claim that this treatment would have the effect of 'levelling the playing field'.

93. The level playing field has become totemic as a goal for the market in public services. The Office of the Third Sector's action plan is typical when it proclaims that "at the heart of this action plan is the principle that where services are commissioned and procured by government, there must be a level playing field for all providers, regardless of sector".[108] Ed Miliband told us that "our policies are aimed at helping those third sector organisations that are well placed to deliver public services, to compete on a level playing field when bidding for contracts".[109] Very few of the organisations we heard from disputed that this was an appropriate goal of government policy.

94. As we inquired deeper into the question, however, things became more complex. It became clear to us that there was no consensus as to what a level playing field entailed. Indeed, the differences between alternative perceptions of what it meant were so great that, on the one hand, the Commissioning Joint Committee believed that most third sector organisations enjoyed a level playing field already,[110] while on the other, Campbell Robb believed that fields could never be entirely level.[111]

95. We do not wish to become bogged down in the semantics of what constitutes a level playing field. No metaphor can be expected to summarise a policy adequately; and yet we have seen surprisingly little discussion as to what this government commitment does and should mean in practice. In particular, there appears to be a confusion between the pursuit of equality of outcomes, so that every sector wins its "fair share" of contracts, and the pursuit of fair procurement processes, which do not provide any sector with a guarantee of a role. It is the latter which the Commissioning Joint Committee told us they believed to be already substantially achieved—but they also told us that this was not enough to achieve the Government's goals for third sector involvement:

We entirely agree that playing fields have to be level. By this we mean that there must be no unnecessary impediment to serious tenders of any sort; and that, if clients can do anything to help any sort of competent tenderer to compete which does not hinder other such tenderers, then they should do that too.

112

96. This chapter considers difficulties with commissioning processes identified in our inquiry, and the steps that the Government is or could be taking to get better outcomes from third sector involvement in public services. In particular, we heard concerns that commissioners were demonstrating perverse practices, including unnecessarily short-term contracting, denial of full cost recovery and misjudging the most effective scale of contracts. We also heard financial reasons why third sector organisations were not reaching their perceived potential, and that there was a wider power imbalance between third sector organisations and the State which required special protection or promotion for those organisations. We take each of these broad critiques in turn.

"First do no harm": eliminating perverse practices

97. It was clear from our evidence that many third sector organisations struggle to engage with public procurement processes as currently undertaken. A typical analysis came from the Camberwell-based charity Cambridge House, who reported some of the barriers they have come up against in tendering for their Independent Mental Capacity Advocacy work in London:

i) Very short turn around of release of tender documents (one only gave a week) to submission.

ii) 80 page legal contracts that are irrevocable on signing just at the tendering stage.

iii) Said legal contract puts all the liability on the organisation. We are fortunate in that we have pro bono legal advice—most organisations would not have this. Our legal advisors have been horrified by the language and liability being presented for a £40,000 per year contract compared to what is usual in the private sector.

iv) In one instance having to pay over £800 to a credit checking agency just be able to submit a tender. We have achieved Gold status which means we have a certificate to say this and can get bumper stickers to confirm it as well. We have had to understandably question the use of charitable funds in paying for this credit check.

v) Having less than a week's notice of being called to interview.[

113

98. The experiences of Cambridge House are merely illustrative, and do not all represent the experiences of every third sector organisation which has attempted to bid for a public service delivery contract. However, it is immediately apparent that a lot of these practices are damaging to the attempt to get the best out of potential providers. They will put some bidders off; they will waste bidders' resources; and they will prevent bidders from having the opportunity to really consider what they might bring to the table. Some of these perverse practices will militate against getting the best out of any provider, not necessarily just third sector ones. Small businesses for example may equally struggle. However, businesses arguably have clearer incentives—i.e. profits—to find ways to jump through bureaucratic hoops in pursuit of contracts. Third sector organisations are not profit driven and rarely resource-rich, and that hoops that a business might jump through readily may appear more like insurmountable barriers.

99. One example of a third sector-specific perverse practice is the clawback of surpluses, where elements of surplus made under procurement arrangements are expected to be returned to the public funder. Barnardo's told us they had been offered contracts with provisions expecting unspent money to be returned to the commissioner.[114] The Charity Commission told us that such practices had been mentioned to them at their conference in March 2006. We cannot imagine commissioners expecting private sector providers to behave in this way; it is understood that private providers will seek to maximise profit to shareholders. Of course third sector organisations do not pursue profits for shareholders, but this does not mean they should be denied any incentive to achieve economies and deliver surpluses for reinvestment. Public bodies should not be attempting to claw back surpluses from third sector organisations in contractual arrangements.

100. There is little scope here for debates of principle: procurement practice that specifically discriminates against organisations of any one sector ought to be eradicated. Unfortunately, a number of such practices working against third sector organisations were reported regularly though the evidence we heard. Disappointingly, these are practices which government identified as far back as 2002, when it undertook to work towards addressing them. The avoidance of these practices are also central to the Compact Code on Funding and Procurement to which central and local government funders are expected to have signed up. On the other hand, the issues around these practices are not necessarily as clear-cut as they seem. We concentrate here on two areas which were raised with us repeatedly—multi-year funding, and full cost recovery.

SHORT-TERM CONTRACTS

101. One potentially perverse aspect of government practice which we heard about throughout the evidence was the short term nature of many contracts commissioners let with third sector organisations. Time and again our witnesses complained that contracts were too short—evidence we heard not just from within the sector, but from public sector bodies like CIPFA[115], the Charity Commission, the Commission for the Compact and the Commission for Rural Communities. Nor is this a new phenomenon. The 2002 Treasury Review identified short-term funding as a major problem for third sector organisations and saw renewable one-year contracts as the principal cause for concern. As long ago as June 2005 the NAO was already reporting that progress on achieving longer-term funding was too slow.[116]

102. Martin Narey—who has experience of long term contracting in the prison service—told us in July 2007 that around 70% of the contracts being delivered by Barnardo's expired the following April:

As things stand in the northwest—and I have no reason to believe that this is very much worse in the rest of the UK—at the moment [July] for about 70 % of our work we do not know whether we will be doing it on 1 April, either because contracts are coming to an end, work is being taken back in house or because local authorities have indicated that they want to continue but they are not sure yet whether or not they will have the funding, and they have within the contracts the ability to give notice to quit if they do not find the money. So it is a very unstable environment.

We now know that Barnardo's lost only 5% of its work in that April, and so the great majority of its contracts were renewed. We have no reason to believe the position of Barnardo's in any of these respects is not typical; a recent Charity Commission survey suggested that around two thirds of contracts were still on a one-year basis.[117]

103. Both trade unions we heard from also told us about the difficulties for staff of working with such a high level of uncertainty. Rachael Maskell of Unite, which has 60,000 members working in the third sector, asked us to imagine the experience of an employee in that scenario, "wondering at the end of that period how you are going to pay your mortgage, feed your family and what about your own career".[118] Barnardo's put their experience into context by telling us that at the end of January 2008 they had issued redundancy notices to over 100 staff across England, and 261 more staff knew that they might also be issued with redundancy notices. They were subsequently able to withdraw notices as contracts got renewed, but all the staff affected must have feared for their jobs.[119] This must affect morale, and the perceived desirability of working in the sector.

104. Possibly more important still than the effect on staff, however, is the effect of uncertainty and change on service users. Debra Allcock Tyler of the Directory of Social Change gave us a poignant example of what this could mean for those who were intended to be the ultimate beneficiaries of this whole policy agenda:

Manju, when she was 13, was raped by her uncle and younger brother, and as a result of that got pregnant. Her family booted her out and she ended up in various psychiatric wards and foster homes and several times tried to commit suicide. She ended up at this particular counselling charity, and had not attempted suicide for about five years as a result of that.

120

105. Some contracts are for schemes which are themselves short-term, but too many service delivery contracts still appear to be unnecessarily short. Nobody seems to be claiming that one-year contracts are generally sensible. Although there are disadvantages of overlong contracts too, in that it is harder to secure accountability to commissioners, there are clear practical problems with the length of many contracts currently. Repeated changes of provider are bad for staff; more importantly, they are bad for service users, who often need to build up relationships with service providers. Nor is it to anyone's advantage if service delivery organisations are unattractive places to work.

106. Government has talked for some time of a three-year norm for contracts, and longer where appropriate. It is time that this was translated into changed practice. However, we understand that this is not easy. The National Audit Office reported in 2005 that good intentions here were being lost as funding flowed through the delivery chain. The decisions on contract length are made by individual commissioners and not by central government. The priority for the Office of the Third Sector, therefore, must be getting the message through to commissioners on the ground.

FULL COST RECOVERY

107. Another area where the State is often accused of not acting in its own best interests is in the enabling of full cost recovery—the principle that payments to third sector organisations should cover the full costs of the services they deliver. Government committed to the principle in 2002 when it asserted a target that by April 2006, all departments would ensure "that the price for contracts reflects the full cost of the service, including the legitimate portion of overhead costs".[121] However, few third sector organisations report experiencing a consistent commitment to this principle in practice. The evidence of the British Red Cross was typical:

122

108. A recent National Audit Office report on full cost recovery outlined the value for money risks posed to government by failure to meet full costs—both short term risks to the quality and effectiveness of underfunded services, and longer term risks to the sustainability of the service and the market of suppliers willing to provide it. The report found no dispute from commissioners on the fairness of the financial principles underpinning full cost recovery, but did find concerns about what these principles meant in practice. The NAO reported that this was particularly problematic in procurement-type relationships where bidding organisations are not necessarily required to spell out their costs to commissioners, and where third sector organisations may not seek full cost recovery for a number of legitimate reasons.

109. Third sector organisations might for example want to deliver a service beyond the contract specification, and supplement the contractual income with their own money raised by other means. Or they might want to improve their chances of delivering a service for their beneficiaries under contract by bidding at a price that would incur a financial loss and subsidising from charitable funds. The complexity for commissioners therefore is that while they have a responsibility to not put up barriers which may prevent bidders from recovering all of their costs, they also have a responsibility to not discriminate against third sector organisations by requiring they recover their costs if they do not wish to do so. The New Economics Foundation provided us with an example of double-discrimination on this issue, where a commissioning body was demanding third sector bidders priced on a full cost recovery basis while exempting private bidders from this requirement and therefore allowing them to undercut the third sector. Additionally, third sector bidders were told their overheads should not exceed 10 per cent of the price, thus rendering the cost recovery process arbitrary and not based on a realistic assessment of costs at all.[123]

110. Richard Gutch suggested much of this kind of poor practice was a cultural hangover from relationships that used to be based on grants:

124

111. This concept of "grant spectacles" may go a long way towards explaining why a sector-specific idea like full cost recovery is often misunderstood in contracting relationships. A similar mentality may be responsible for the practice of clawback (discussed at paragraph 99), which is another hangover from grant funding arrangements. Neither approach represents a professional approach to commissioning. It is interesting too that while the NCVO and acevo continue to call for full cost recovery in their submissions to this inquiry, both organisations have also noted that bidders have a responsibility of their own to understand and reflect their own costs when they put in bids.[125] This is an important recognition for professionalism around costing and pricing on the part of the sector too. Commissioners need to lose the habits of grant funding when dealing with third sector organisations in competitive procurement processes. The onus should always be on the bidding organisation to decide how much they want to charge. The responsibility of the commissioner is to ensure that there are neither arbitrary barriers preventing them from doing this, nor discriminatory requirements to compel them to charge their full costs where they may not wish to do so.

112. It is important to recognise that full cost recovery is not a right—it has to exist in a competitive context. While bidding organisations should not be prevented from pricing their full costs into a bid to provide a particular service, commissioners will always retain the right to reject that bid in favour of a cheaper competitor. Government's commitment to full cost recovery does not, and should not, immunise the third sector from the pressures of efficiency and competition.

113. In a competitive contracting environment, commissioners retain a residual duty to consider and manage the risks that aggressively low bidding might pose to the quality or sustainability of a service or a market, and act accordingly when selecting a preferred provider. However, responsibilities towards organisational sustainability remain the prime responsibility of third sector organisations themselves. This reinforces the importance that bidding organisations understand their full costs before entering the procurement process.

Judging the scale of contracts

114. We began this chapter with Will Werry's question of why, if the sector had so many qualities, it was not winning now. For Mr Werry, there was a ready answer to his own question: too many things in the procurement process were geared up to bigger contracts for bigger operators.[126] Again, as on contract length, this argument was put to us by an enormous range of bodies and individuals as a key flaw in commissioning practice which was having a significant deleterious effect on the Government's intention to get the best out of the third sector. In particular, contracts were seen as being too big for most third sector organisations even when they acted in partnerships—sometimes even when government appeared to have specifically believed that the service was one which third sector providers would be particularly suited to providing.

115. We have cited at paragraph 97 the negative experiences listed by Cambridge House in the procurement processes they had undergone. Despite these difficulties, Cambridge House told us they had been able to equip themselves for tendering processes. However, they were a "large local provider", and they did not believe others would be in the same position:

127

From his experience of supporting smaller organisations, Alex Whinnom felt the chances of successful engagement with such processes to be 'hopeless'.[128]

116. Stuart Etherington told us that the drive for scale and efficiency in public procurement represented in some respects a counter-pressure to government's desire to work more with the third sector:

129

During the course of our inquiry the Department for Work and Pensions (DWP) conducted a controversial procurement process which illustrated the tension well. Pathways to Work is a DWP programme aimed at getting people on incapacity benefits into work. It is a scheme which was designed to be administered by external contractors, with one contractor charged with administering the scheme in each of the country's 31 Jobcentre Plus districts. Employment services is an area where the third sector has a history of successful involvement and one where, according to the NCC's research, the third sector appeared to have distinctive qualities perceived by service users. Indeed, in the pilot of the Pathways programme there had been heavy third sector involvement on which the Government had reported favourably.

117. Nevertheless the sector was, in the words of acevo Chief Executive Stephen Bubb, 'comprehensively stuffed' in the first stage of the DWP procurement process, winning just 2 out of the 15 contracts given out at that stage—both to the Shaw Trust. Acevo's response was to commission an inquiry, chaired by Dame Mavis MacDonald. That inquiry made a number of recommendations including clearer consideration of desired long-term outcomes, the wider use of social clauses and clarity on the extent to which European law allowed government to specifically target third sector providers.[130] We will come onto each of these later in the report. The subtext, though, is clear—that government operated this particular procurement exercise around contracts too large for many third sector organisations to consider.

118. Invited to comment on the result of this exercise, Ed Miliband told us that there was a tension which government needed to acknowledge between the pressures of efficiency and the need for smaller organisations with local knowledge to be involved.[131] This is a welcome acknowledgement from government that efficiency is not all, and must be balanced against other objectives; but equally, as Dame Mavis MacDonald acknowledged, the third sector needs to recognise that efficiency is a legitimate objective too. In designing each procurement exercise, the challenge of the commissioning body is to try and determine the trade-off between affordability and service quality to the best possible extent.

119. In the case of Pathways to Work, the Government was also able to point to a much larger involvement of third sector organisations at a sub-contracting level. We now know that around half of the sub-contractors to the successful primary contractors were third sector organisations.[132] Stuart Etherington intimated that he believed this would be the shape of things to come for third sector involvement in public service delivery:

133

Moreover he was optimistic that on a commercial and operational level this might not necessarily be a bad thing for third sector organisations, describing one example of a third sector organisation subcontracting with a private provider to DWP:

Interestingly, when I asked the voluntary organisation what was their experience of sub-contracting from a private-sector contractor to the DWP, I expected a sort of torrent of abuse but I was quite surprised: they said, "Oh, no, it's much better than contracting with the DWP."

134

120. Third sector organisations may indeed be treated in a more business-like way in sub-contracting arrangements. However, there are other concerns which need to be considered here, such as the possible removal of the protections embodied in the Compact from a growing proportion of service providing third sector organisations. Sub-contracting also of necessity adds a layer of management, with the potential to increase costs and blur accountability. Meanwhile, another solution for involving smaller or more local organisations is wider use of consortia. Phil Hope told us that consortia "can be a very powerful way that third sector organisations can play a part in these larger contracts".[135] He cited the example of Cross-Herts Community Counselling, where six youth and children organisations that provide counselling and advice to young people had got together to bid to deliver services such as sexual health advice to children and young people, aided by an investment from Futurebuilders.[136] Sylvia Sham told us that Wai Yin had also had a positive experience of forming a consortium:

By working with another ethnic minority group from another partnership … we put our tender … more strongly, not only from one ethnic group. We put the tender together for the Learning and Skills Council to get the funding to deliver for about 2,000, as you call them, "hard to reach groups", to get them from no English to the level of English which is very simple: to go the bank to say, "I want to open an account" or to go to the post office to have a stamp-the simple things they want to learn-and then to progress them into work.

121. The growth of consortia is encouraging. We do not believe, however, that it is yet at a scale that is going to affect significantly the overall shape of the public services market. It is also costly and time consuming for organisations to come together into consortia. Alex Whinnom told us that he was involved in a learning consortium in Greater Manchester with around 28 voluntary learning providers in it, including some very small ones which are reaching very hard to reach groups, looking to win contracts from the Learning and Skills Council. Even with 28 providers involved, so that they "could easily handle a contract worth £1 million between us", all the contracts had been on such a large scale that they could not bid for any of them, aside from one about delivering grants to third sector organisations.[137]

122. It is evident to us that even where there is some evidence that distinctive potential to transform public services does exist, such as in employment services, it risks not being captured due to the nature and scale of the procurement processes in place. Sub-contracts, which third sector organisations are having more success at winning, carry their own risks, and may still be too large for some of the most distinctive organisations; consortia of a sufficient size are hard to establish and maintain. If government wants to involve the smallest organisations who sometimes offer the most distinctive services, it may have to look at doing a number of things:

radically simplifying its tendering processes;
helping organisations to bid, and in particular helping them to form consortia and allowing sufficient time in the commissioning process to do so;
incentivising prime contractors to work with third sector sub-contractors and build their capacity to participate in the commissioning process; or
identifying opportunities to advertise contracts at a significantly smaller level.

Financial disparities

ACCESS TO CAPITAL

123. Even beyond simple differences in the size and financial stability of third sector organisations and counterparts particularly in the private sector, there are particular difficulties which third sector organisations will face in the pursuit of large-scale contracts. One commonly mentioned inequality was that in the third sector it was more difficult to access capital. Phil Hope cited this in answer to our question of whether the third sector had any inherent weaknesses:

Access to finance is one area where we have been keen to see if we can improve services and support for third sector organisations. I think that is one of the weaknesses.[

138

124. It does not require much explanation to realise that smaller financial reserves will disadvantage organisations, in that money buys the capacity to bring in new staff and new skills. We heard from Barnardo's that most of their work is won against other third sector organisations. Stuart Etherington told us that it was "simply a fact" that most contracts for service provision were being won by the private sector.[139] Sylvia Sham spoke eloquently of the challenge for small third sector organisations trying to take on private sector competitors:

140

125. Money also helps mitigate any risks associated with service delivery, from the overarching risk that providing a service turns out to be hugely more expensive than originally forecast to the more mundane risk that money will be wasted on bids for contracts that are ultimately not won. On this latter question, it is worth noting that even a large, established and well respected charity like Barnardo's was unsuccessful in 33% of its contract bids in 2006 (91 out of 275). They estimated that the approximate cost to Barnardo's in 2006 of unsuccessful bids was £182,000, or just under 0.1% of their turnover. They also calculated that Barnardo's spends about 1.8% of the total value of a contract in preparing for that bid.[141]

126. To an extent the problems recounted here are not dissimilar to those that small businesses might face on trying to enter such markets. The Government, though, has been convinced by the case that there are specific difficulties for third sector organisations here, as well as wider public policy reasons for building the capacity of the sector in that it provides benefit to the public in a number of ways (as has long been implicitly recognised through grant funding). Capacity building is therefore about more than just equipping third sector organisations to deliver public services. The Government is committed to improving the capacity of the third sector across all of its identified roles, from campaigning to strengthening communities. Its particular vehicle for investing in the infrastructure of the sector is the ChangeUp fund, which has been delivered since April 2006 by an organisation called Capacitybuilders.

127. The ChangeUp fund was backed by £150 million up to 2008, and a further £83 million has now been allocated over the years covered by the 2007 Comprehensive Spending Review (CSR). The Third Sector Review promised that over the 2007 CSR years Capacitybuilders will have an increased focus on ensuring that infrastructure organisations are equipped to reach down to the smallest third sector organisations, building capacity at a community level.[142] This programme sits alongside work by Regional Development Agencies to support social enterprises and expectations on local authorities to maintain thriving third sectors in their areas. It is a laudable enterprise in its own right. On the other hand, it is unlikely in practice to reach the types of third sector organisations who are doing most of the sector's bidding for service delivery work.

128. The limits of existing capacity building funds were recognised when the Government instituted the Futurebuilders fund following the 2002 cross-cutting review of the sector. Futurebuilders was explicitly set up to improve public service delivery through long-term investment in the third sector, and by the time of the Third Sector Review in 2007 Futurebuilders had made 239 investments totalling £101.9 million to 225 schemes.[143] Although originally focused on particular services, as of April 2008 the fund is now open to all third sector organisations working to deliver public services. The fund was administered for its first few years by an independent non-profit company called Futurebuilders England Ltd, set up by Charity Bank, the NCVO, Northern Rock Foundation and Unity Trust Bank. However, the organisation lost its bid to deliver the second phase of the scheme, and as of April 2008 the fund is being administered by community lender the Adventure Capital Fund (ACF).

129. Futurebuilders mainly lends money rather than giving grants. Nonetheless, the former Commissioner for the Compact, John Stoker, referred to the scheme as "money put where the Government's mouth is".[144] Even the CBI, who might be considered to represent the rivals to third sector providers, considered that "if the Government takes the view that the voluntary sector can help with a policy objective and needs to encourage them by pump-priming the market then yes, they should".[145]

130. However, we did not hear universal praise for the Government's steps to build third sector capacity. The Audit Commission told us that the ChangeUp programme had "proved administratively complex" and resources had not filtered through to front line voluntary sector organisations delivering services. The Futurebuilders fund, meanwhile, had "proved unable to help many smaller organisations, who are often unwilling to take on debt obligations".[146] It may also have been telling that when Selwyn Image of Emmaus pressed us to call for a new attitude towards capital grant funding, in which the State saw itself as a venture capitalist, he made no mention of Futurebuilders, the Government's existing venture capital fund (albeit one directed at organisations bidding for contracts rather than grants).[147]

131. Lord Adebowale, whose organisation had made use of Futurebuilders funding, told us that it was a long way short of the funding available to private sector competitors. He called for a Voluntary Finance Initiative (VFI), equivalent or comparable to the PFI but for third sector organisations:

148

We heard no clamour for a VFI in our inquiry, however. Ultimately, it is not as easy as a third sector organisation as for a private sector counterpart to take financial risks on such a large scale. Local Compact Voice told us that third sector organisations would rarely be in a position to take such risks in practice:

149

132. The Charity Commission told us they would be concerned if charity trustees were involved in activities where they did not recognise the degree of financial risk they were running.[150] The Mental Health Provider Forum told us that "the third sector cannot play venture capitalist or take the same financial risk on investment which can make sense for a commercial player."[151] These observations contained a dose of realism, as did those from Cambridge House:

152

133. If a level playing field is taken to mean that third sector organisations are able to compete as financial equals with potential providers in other services, then it will never be achieved. Most third sector organisations, including many who have the characteristics government is looking for in service delivery, are too small to compete for most contracts. Capacity-building is important in itself for reasons beyond service delivery, and it has a role in pump-priming particular would-be service providers, but it will not in itself achieve a level playing field in service delivery.

OTHER DISPARITIES

134. Beyond access to capital, we heard other difficulties in attempts by third sector organisations hoping to compete financially with other sectors. The Charity Finance Directors' Group (CFDG), for example, raised the questions of VAT recovery and pensions:

The voluntary sector is uniquely disadvantaged because it operates in an environment where there is no level playing field on issues such as pensions and VAT. Voluntary organisations find themselves competing against private sector and other government bodies for the same contracts but without the same terms and conditions.[

153

The CFDG explained to us that a lot of the services provided by charities are either exempt from VAT (ie they cannot charge it, and so cannot recover the VAT that they pay on their purchases), or they are non-business supplies (because the charity does not charge for the service or heavily subsidises it) and are outside the scope of VAT. In either case, the charity ends up with a substantial irrecoverable VAT bill. Commercial organisations providing services do not have this problem as they almost exclusively provide taxable services, while local authorities receive an automatic refund of the VAT that they pay on providing services, many of which are identical to those provided by charities. The Charities' Tax Reform Group (CTRG) estimates that irrecoverable VAT costs charities in excess of £400 million a year.[154] The suggestion that charities are "almost uniquely penalised" by the VAT regime appears to have some force (although of course charities have their own tax advantages as well).

135. Pensions, meanwhile, are part of a wider difficulty that third sector organisations might have with requirements under the Transfer of Undertakings (Protection of Employment) Regulations 2006—known as TUPE—to take on staff when services transfer, and maintain their existing levels of salary and benefits.[155] Will Werry told us that TUPE was particularly problematic for third sector organisations because it was "designed to make it not a factor in tender evaluation", and because the British Government had exercised its right to apply it to pension rights as well.[156] The CBI's Neil Bentley told us that he was not sure there was the capacity available in the sector with transfers of staff.[157] TUPE appears likely to cause practical difficulties when services are moved into the third sector. Many organisations will not have the capacity to take on staff at existing levels of salaries and benefits. If the Government is committed to pump-priming the third sector to improve service provision, it will need to invest in supporting third sector organisations who are effectively prevented from delivering services by the requirements of TUPE.

136. Another problem that third sector organisations sometimes face is the requirement that bidding organisations should be over certain thresholds to enter into competitions. Such thresholds can be set in such a way as to effectively exclude third sector organisations. Peter Kyle gave us one example:

The Olympics, for example, had as one of the rules for entering the commissioning process that you must have a turnover of £5 million for community transport, even as a sub-contractor. There is only one third sector organisation which has a turnover of that size and is in the business of community transport, so lots of other people could not enter the bidding process because of that one rule.

158

Interestingly, the contract to provide the bus service for workers in the Olympics was subsequently awarded to a new social enterprise formed by Ealing Community Transport and Hackney Community Transport. Hugh Sumner, Director of Transport at the Olympic Delivery Authority, was quoted as explaining that the enterprise won the contract "because of its commitment to making a difference to the areas in which it operates, primarily targeting the unemployed locally, who it then recruits and trains to drive its vehicles".[159] This seem to be an example of intelligent commissioning, taking added value into account, although we do not know if the £5 million turnover requirement had to be dropped in order to achieve this outcome.

137. Several of our witnesses told us that the problem with contractual specifications was particularly prevalent in insurance requirements. Alex Whinnom told us that he had recently filled in an application to deliver city strategy work on learning and skills for a district of Greater Manchester where they required £10 million worth of public liability insurance to qualify.[160] Sylvia Sham told us the cost of this:

161

138. Local Compact Voice mentioned to us the suggestion that there could be a Third Sector Insurance Fund.[162] However, such a fund would not be necessary if bidders factored in insurance costs when making their bids. Private sector bidders certainly will do so. The insurer Zurich explained why this is so important:

When community and voluntary sector organisations take on the running of public services they also take on significant amounts of extra risk. This ranges from the day to day operational risks to the macro strategic risks inherent in running such services. An operational risk in a contracted out meals on wheels service could be an increased likelihood of injury to volunteers due to lifting; a strategic risk could include volunteers not arriving at the allotted time and the service being unable to function on a particular day.

163

139. There is a legitimate question of whether government, ultimately responsible for ensuring public services are delivered, can ever really outsource risk. This question is often debated in the context of PFI deals, and boils down ultimately to whether government can ever tolerate a public service failing. This question goes well beyond the scope of this inquiry, although it is clearly of central importance. In the context of this inquiry, the central observation which comes out of Zurich's evidence is that government could, by transferring too many risks onto providers, cause those providers to fail. That would be an undesirable outcome not only for the service provider, but for the commissioning body (who presumably wants the service to be delivered) and for the service user. In practice, therefore, the commissioning authority is always likely to step in rather than allow the provider to fail—but often only after significant turbulence and at considerable extra cost. There is clearly an onus on government not to outsource undue risk to third sector providers, or any other providers, without fair recompense—but the fair sharing of risk is in everybody's interest, if services are not to be allowed to fail.

The role of the Compact

140. The reason why it is possible for too much risk to be outsourced is because there is an imbalance of power in the commissioning process—possibly particularly likely to manifest itself in relation to third sector organisations. Commissioners have, in general terms, much more experience of the tendering and contracting process than most bidder organisations, particularly when the Government looks to involve the smaller, more niche organisations. A common complaint from smaller organisations was that contracts are long, technical, difficult to understand, and vary greatly from one area to the next. This was a complaint we heard particularly forcibly from Alex Whinnom.[164] It would be all too easy for unscrupulous commissioners to insist on contractual stipulations which transferred unreasonable levels of risk to small providers. This is the logic behind the commitments to the sector embodied in the Compact.

141. The Compact is the agreement between government and the voluntary and community sector to improve their relationship for mutual advantage and community gain. As we have seen, it was established in 1998 as a result of a recommendation from the Commission on the Future of the Voluntary Sector in England.[165] Campbell Robb explained that the Compact was designed to address specifically the imbalance of power between government and the sector:

166

142. The terms of the Compact go beyond the commissioning relationship to look at all aspects of the relationship between the public and third sectors. We consider some of its principles in chapter 8. However, the interaction between the Compact and the pursuit of a level playing field in commissioning is particularly important to this inquiry. After all, other sectors do not have a Compact, so it could be interpreted as un-levelling a playing field by giving preferential treatment to the third sector. John Stoker, the former Commissioner for the Compact, conceded as much:

167

143. The difficulty with this special consideration is that it is not easy to reconcile with rules guaranteeing fair treatment for all potential providers—as set out in the EU Procurement Directives, and implemented in England, Wales and Northern Ireland by the Public Contracts Regulations 2006. In their submission to us, the Office of Government Commerce explained how limited commissioners' capacity was to discriminate in favour of third sector providers. Only issuing tender documents to third sector organisations would be discriminatory and lack transparency. Direct awards of a contract without an advert or competition would only be permitted in specific, highly exceptional circumstances. Even advertising predominantly in the third sector press could be discriminatory in European law.[168]

144. These restrictions exist, as the OGC reminded us, to guarantee the principles underlying the EU Treaty: non-discrimination, equal treatment, transparency, mutual recognition and proportionality.[169] It is for these reasons that commissioners have little choice but to opt for the best provider without any ideological predisposition. The larger third sector organisations we heard from were also strongly supportive of this sector-blind approach as practical as well as principled, encapsulated by Lord Adebowale's observation that Turning Point had no right to exist or to be given work, but should be judged in each bid on its merits.[170] Competitive neutrality is also totemic to the CBI.[171] The gist of all this evidence was that the market in public services is a place where the organisations have a choice if they want to get involved, and do so at their own risk—an idea that might be summarised as "seller beware".

145. How, then, can commissioners reconcile the EU principles and "seller beware" with the power imbalance leading to the commitments in the Compact? John Stoker told us that the Compact Code on funding and procurement explicitly states that they are consistent with the requirements of Government Accounting and EU procurement law, and that they apply in contract relationships as well as grants.[172] He did concede, though, that this posed difficulties for commissioners:

173

146. There are limits to the differential treatment which commissioners can give to third sector organisations in a procurement process. If Compact financial undertakings are to be built in to tender exercises, they must apply to all sectors equally. Therefore, while the Compact may have value in a contracting environment in redressing imbalances between buyer and seller, it does not level the playing field between bidders from different sectors.

Conclusions—careful contours

147. With less access to capital and less capacity to take risks, there will always be practical limits to the third sector's ability to compete for certain contracts, especially the largest ones. The Government accepted this when Campbell Robb assented to our proposition of a "carefully contoured playing field" as the realistic goal.[174] It is legitimate for the Government to pump-prime the sector and invest in building its capacity, both in general terms and specifically to aid public service provision, as long as it does not unfairly advantage third sector organisations over rivals for service delivery bids. At the moment this seems some way off happening, and so we see Futurebuilders and Capacitybuilders as laudable schemes.

148. There is a limit, though, to what can be done by attempts to eliminate inherent disadvantages of third sector organisations when those disadvantages can arise out of the same characteristics that might make them distinctive. If government wants more third sector organisations to deliver services, then the most effective way will be to ensure that commissioners set out requirements when they commission services that play to these organisations' distinctive qualities. Where there are any barriers, these should be eliminated, and capacity building will play an important part; but the key to improving outcomes will be ensuring that there are the right people in the job, with the right skills and knowledge to use their legitimate client discretions more wisely. The key is intelligent commissioning. We explore this in more depth in the next chapter.

106 Q 68 Back

107 Ev 263 Back

108 Cabinet Office, Partnership in Public Services: an action plan for third sector involvement, December 2006, p 3 Back

109 Ev 149 Back

110 Ev 125 Back

111 Q 181 Back

112 Ev 124 Back

113 Ev 190 Back

114 Ev 146 Back

115 The Chartered Institute of Public Finance and Accountability Back

116 National Audit Office, Working with the Third Sector, HC (2005-06) 75, p 45 Back

117 Ev 192 Back