After Carillion: Public sector outsourcing and contracting Contents

4The Government’s approach to contracting: managing risk

The Government’s power as a purchaser

50.Irrespective of whether the Government decides to increase or reduce what it buys from the private sector, it will still purchase some services or goods from the private or voluntary sector

51.In some markets, as we heard, the Government buys services in the same way as any other entity would: the Minister told us, for example, that in markets like those for business processes (such as generic accounting or human relations functions), the Government does not dominate.114 However, in other markets the Government as a buyer does dominate. Rupert Soames, Chief Executive of Serco, described the Government, in these markets, as a “monopoly buyer”.115 Sir Amyas Morse, the Comptroller and Auditor General, said that in some markets, such as prisons, Departments “are the sole customer”.116 The Government’s position as a monopoly buyer (or “monopsonist”) may be ameliorated in some areas by the increasingly international nature of the market for public services.117 In the aftermath of the collapse of Carillion, the Government asserted that it was just another customer but as a monopsonist buyer this cannot be true.118

52.Where the Government has this monopsony position it is, as Margaret Stephens, a former KPMG partner, told us “very influential in terms of behaviour” in the market.119 She is not alone: the NAO has said that in these markets the Government enjoys “significant market power”.120 Where the Government has monopsony power, its approach to contracting determines the behaviour of the market. Professor Sturgess said that the current literature on contracting lacks “sufficient awareness” of the Government’s dual roles in these monopsonistic markets as both the monopoly buyer and the ultimate market steward.121

53.The Government’s position in some public sector markets is monopsonistic. It has huge power as the only buyer in those markets to set prices, standards of quality and to determine the behaviour of participants. The Government should recognise in its response to our report its position as a monopolistic buyer in some markets and commit to publishing a strategy which would identify what it thinks the risks that arise from this are, how it can mitigate them and what it can do to improve these markets and render them more stable.

The Government’s approach to contracting

Risk Transfer

54.Ultimate responsibility for any project rests, as David Simmonds from the Local Government Association argued, with the public sector as “they are the ones with the statutory duty to do whatever it is they are procuring for”.122 Michael King, the Local Government Ombudsman, also took this view, arguing that the public sector” can outsource the service but it cannot outsource its responsibilities”.123

55.The Government’s guidance in the Green Book says that risks should be “borne by the organisation that is best placed to manage and monitor” them.124 Sir Amyas Morse, while discussing the case flow of a typical service for vulnerable people, explained what this meant:

if I ask you to sign a contract to take costs down and I make you responsible for the case flow under that contract, and I say, “If you don’t get any more cases, you still have to deliver the same service and I am not going to up the price per case that you can charge”, and I hold you to the contract and I make sure it is on very restrictive terms, I am simply making it impossible for you to be successful in the business”.125

56.Nick Davies provided an example of successful apportionment of risk: in the Thames Tideway tunnel, the Government guaranteed that “for certain catastrophes for example, if drilling happens to flood the Underground” the Government would take the risk as the private sector could not effectively manage it.126 This kind of catastrophic risk contrasts with risks that the private sector can manage, which Nigel Kletz, Chair of the National Advisory Group for Local Government Procurement, described as risks around “day-to-day operational delivery”.127

57.However, despite this guidance, there is evidence that successive governments have sought to transfer risk inappropriately and that they continue to do so. Rupert Soames said that in his view “Government has started transferring unmanageable amounts of risk into the private sector”.128 Michael King told us that “all too often” local authorities try to outsource responsibility for a contract as well as operational risk.129 Professor Sturgess wrote in his recent report that, in his own work with private contractors, risk transfer was the topic mentioned more often than any other as a matter of concern for them.130 The NAO found that the Home Office had allocated risks to Raytheon, the IT contractor on the Eborders programme, which the company had “proved ill-placed to manage” (these included the risk that the company’s designs for the programme did not meet the Department’s detailed specifications).131

58.Professor Sturgess wrote in 2017 that “the experience of recent years has been that procurement teams are aggressively seeking to maximise risk transfer”.132 The IfG agrees: reporting that the Government is “transferring more financial risk onto providers”.133 A recent report by the CBI finds that 37% of businesses who work with the Government felt that the “government’s handling of risk had deteriorated since 2015, with almost half stating there had been no improvement during this period”.134

59.The Government recently used innovative contractual models to do this. The NAO says that, when designing payment by results schemes, the Government needs “to understand potential providers’ capacity to take on risk”.135 It is not clear that the Government have done this. For example, in the Work Programme, the Government “set initial performance expectations too high”.136 They based these expectations on the unemployment rate for the period between 2001 and 2008 even though economic conditions had since changed.137 The Work and Pensions Select Committee described the Programme as “very ambitious” and said that they were “concerned” about the “financial viability of prime contractors” on it.138 Similarly, in the Transforming Rehabilitation Programme, the Government’s initial estimates of demand and cost proved inaccurate.139 In 2014, over 80% of providers reported concerns about their exposure to financial risk on Payment by Results contracts.140

60.Sir Amyas Morse said that, where the Government uses these innovative contractual models, they should set up trials to test what risks can and cannot be transferred and how effectively such models work.141

61.We have found several instances where the Government has contracted with the private sector without knowing key data about the services it was asking companies to bid for. In these circumstances, the Government has asked the contractors to absorb any losses resulting from its own ignorance of the initial condition of the service. Recent examples of this include:

This is still happening. Serco recently disclosed analysis showing that, in twelve recent procurements, the Government asked participants to take on the risk that the Government had got its own data wrong.148

62.Transferring too much risk can be counterproductive. On the Work Programme, the Work and Pensions Select Committee found that “elements of the programme have inhibited genuine innovation in the services delivered to participants, often leading to a fairly generic set of interventions.”149 The IfG found that “providers concerned about their financial survival are generally unwilling to take on further risks by doing things differently”.150 A recent study of payment by results programmes notes that “because of the financial risk transfer to providers” these programmes have “been more likely to stifle innovation” than stimulate it.151 This is not merely an issue with payment by results: the CBI’s 2018 survey of 250 firms found that only 5% thought that current public sector procurement policies “incentivise innovation”.152

63.UK governments have often transferred risks to contractors that they cannot possibly manage. This is driven, in part, by the decision to use contractual models such as payment by results which involve risk transfer on a huge scale. The transfer of large amounts of risk is often counter-productive: leading to more conservative approaches to service delivery. This situation has been made worse by the fact that governments have often not understood fully the services or projects they have wanted the private sector to manage and without any understanding or data about the assets being handed over.

64.The Government’s guidance on risk transfer is sensible but too often that guidance appears to have been ignored in Departments. The Government must ensure that in the future this guidance is followed. In areas where the Government lacks information about the state of existing provision of services, it must evaluate which risks its partners are capable of taking on and which risks must remain with the Government. The Government ultimately cannot outsource the need to understand what it is outsourcing. We expect the Government to set out to us new procedures to ensure guidance about risk transfer is followed in the future. For example, contract announcements could be accompanied by a disclosure of which risks each party has agreed to manage.

65.The complexity of risk management is exacerbated in some of the innovative contractual models that the Government has used recently. The Government should pause its roll-out of these models, such as payment by results, given the difficulties the Government has had in evaluating which activity leads to outcomes and working out costs. In areas where payment by results has been implemented, we believe that the Government should, if it decides to re-purchase the services, re-evaluate how it apportions risk between itself and providers. The Government should in its response to this report lay out how it would do this.

Pricing of public sector contracts

66.The Government appears to focus unduly on cost in its contracting decisions, with a detrimental effect on service quality. The British Institute for Facilities Management complained about “a continual drive for the lowest price” on the part of the Government.153 The National Council of Voluntary Sector Organisations said that government contracting was “primarily driven by price exclusively”.154 Sir Amyas Morse said that it was “certainly not unusual” to see Departments accepting the lowest priced bid when procuring for a service.155 Paul Davies portrayed the Government as “pushing the lowest cost”.156 Professor Sturgess wrote that “competitive tendering [is] being actively used to drive down prices, with the fees paid for some mature contracts reduced by 25–30%”.157

67.Government contractors are acutely aware of the focus on cost. Rupert Soames told us that “in the four and half years that I have been running Serco I know one occasion” in which Serco had won a contract despite not having the lowest bid.158 Phil Bentley agreed that price was “pretty important” to winning bids.159 The CBI, in a recent survey of 250 contractors, said that only 2% of them thought that service quality was the determining factor in the award of Government contracts, whereas 60% thought it was the lowest initial bid cost.160 David Simmonds, from the Local Government Association argued, this is a “very much live issue” in social care.161 Karl Wilding, from the NCVO, told us that charities are effectively being asked by the Government to “subsidise contracts with their donated income”; on average, he said, large charities lose 11% on each contract they have with the government.162 Consequently he told us these charities are “walking away”.163

68.This has consequences. The Government’s priority to save costs has frequently led to worse services: in the primary care support services contract, the NAO found that NHS England’s assessment of contract risk “focused on the likelihood of it failing to achieve its financial savings target” and “did not adequately assess the risk of Capita failing to provide the service to a good standard”.164 Rupert Soames said that he was concerned that “technical evaluations may be fudged to allow technically poor but cheap bidders to continue in a competition, simply because the customer is desperate for the saving”.165

69.The Government conceded that it has been overly-focussed on cost in awarding contracts. We were told that this is because it has sometimes struggled to understand the outcomes it requires. John Manzoni told us that “we have not had the sophistication internally to do much other than go for price.”166 Gareth Rhys Williams, Government Chief Commercial Officer and Non-Executive Director, Crown Commercial Service, told the Committee that “if we are not acute enough or precise enough about how we evaluate quality, such that each vendor gets eight out of ten, for example, even if the quality scores are 80% of the marks … then price is the only factor” in the procurement. He told us that “we need to get better at assessing quality factors”.167 The Minister admitted that “for too long, Governments have been suspicious of the right of companies to make a fair return on their investment”.168

70.The Government’s approach of pursuing the lowest possible cost and the highest possible risk transfer has flowed from a very transactional approach to contracting. Paul Davies said that the Government have been “very transactional in a lot of their relationships”.169 According to Mr Davies, the Government have ignored “things like robustness, commitment and long-term sustainability” in always focussing on the cheapest possible price for a particular deal.170 John Manzoni agreed; saying the Government were trying to widen the factors that procurement teams were considering in evaluating bids.171

71.The Government’s preoccupation with price has been noticed by the market and is a matter of grave concern. The Government’s failure to assess the quality of services as well as their cost is lamentable. There needs to be a complete reappraisal of how the Government assesses quality of the work it commissions. This will both incentivise providers of services to focus more on quality and ensure there is less chance of providers aggressively undercutting bids deliberately with the intention of potentially renegotiating the contract later on. This is particularly important in cases of complex services for vulnerable people, where the risks and the consequences of service failure are most acute. It is no surprise that the quality and reliability of privately supplied services is so variable if the Government nearly always judges bids on price alone.

Renegotiating contracts

72.The Government’s focus on cost and aggressive risk transfer during negotiations has led to difficulties during the operational phase of contracts. The Government has responded to this in some cases by forgoing performance penalties that were available to it. For example, in the Compass contracts for asylum seekers’ accommodation, the Home Office did not apply performance penalties to contractors during its transition phase, because, as they told PAC, they were engaged in “commercial discussions” with their contractors about the failure to provide them with adequate information.172

73.The Government has also renegotiated the terms of some contracts. In July 2017, David Lidington MP, who was then Secretary of State for Justice and Lord Chancellor wrote an open letter confirming that “we have adjusted the CRCs’ contracts to reflect more accurately the cost of providing critical frontline services”.173 The Justice Select Committee in their report in June 2018 criticised what they described as the “constant renegotiation” of the Transforming Rehabilitation contracts and said that the changes the Ministry made raised “serious questions” about the Ministry’s capacity to let contracts.174

74.Transforming Rehabilitation is not the only example of a programme in which the Government has had to renegotiate contracts. The Government has written to the Committee saying that, since 2016, there have been 12 contracts worth more than £10 million each which have been altered in this way.175 Peter Smith, a former Government procurement director, has written about the potential legal dangers that this may expose the Government to, as UK and EU regulations on contracting are “pretty prescriptive when it comes to changing major contracts post-award”.176 Presumably, such renegotiations involve additional costs to the public sector for legal and other work.

75.The Government’s decision to revise the terms of some contracts underlines the failure of contracting within government. We agree with the Justice Select Committee that these renegotiations point to underlying issues with the capacity of the Government to successfully let contracts. Renegotiation often reflects poor risk allocation and poor information about the original service that was contracted out. The Government is also potentially exposed to legal risk through doing this. We have not received evidence about the costs of bringing in these changes but presume they are substantial. While it may be unavoidable that the Government has to re-negotiate some contracts to ensure services continue to function, the fact that it has had to renegotiate over £120 million of contracts in the last two and a half years is an indictment of its initial negotiating approach.

76.In each case where the Government has had to renegotiate a contract because its initial assumptions about cost, risk transfer or contractual structure have proved incorrect, we believe the Government should undertake a lessons learned exercise to identify what went wrong. The lessons identified in this exercise should be shared with the Comptroller and Auditor General and his officials to decide whether there are any issues to report to Parliament.

114 Q764 (David Lidington MP)

117 Q517 (Sir Amyas Morse)

120 National Audit Office A short guide to commercial relationships (December 2017) p. 24,

122 Q277 (David Simmonds)

123 Q277 (Michael King)

129 Q277 (Michael King)

130 G. Sturgess, Just another paperclip: Rethinking the Market for Complex Public Services, Business Services Association, March 2017, p. 10

131 Comptroller and Auditor General Eborders and successor programmes (December 2015) p. 10, 34

132 G. Sturgess, Just another paperclip: Rethinking the Market for Complex Public Services,Business Services Association, March 2017, pp. 10–11

133 D. Crowe, T. Gash and H. Kippin, Beyond Big Contracts, Institute for Government and Collaborate, January 2014, p. 6

135 Comptroller and Auditor General Outcome-based payment schemes: government’s use of payment by results (June 2017) p 7

136 National Audit Office The Work Programme (June 2014) p. 7

137 National Audit Office The introduction of the Work Programme (January 2012) p. 22

140 D. Crowe, T. Gash and H. Kippin, Beyond Big Contracts, Institute for Government and Collaborate, January 2014, p. 6

143 Ibid. p. 5

144 National Offender Management Service, Annual Report and Accounts 2016–17, p. 69

145 Ibid.

146 Oral evidence taken before the Justice Committee on 26 June 2018 HC (2017–19) 483, Qq 41, 46 (Rory Stewart)

149 Work and Pensions Select Committee, Welfare-to-Work, Second Report of Session 2015–16, HC 363, p. 8

150 D. Crowe, T. Gash and H. Kippin, Beyond Big Contracts, Institute for Government and Collaborate, January 2014, p. 6

151 K. Albertson, C. Fox, C. O’Leary, G. Painter, K. Bailey and J. LaBarbera, Payment by results and social impact bonds: outcome based payment systems in the UK and US, February 2018

153 British Institute for Facilities Management LCC0020

154 NCVO LCC0026

157 G. Sturgess, Just another paperclip: Rethinking the Market for Complex Public Services, Business Services Association, March 2017, p. 18

158 Q647 (Rupert Soames)

159 Q649 (Phil Bentley)

162 Q699

163 Q699

164 Report by the Comptroller and Auditor General NHS England’s management of the primary care support services contract with Capita, Session 2017–19, HC 632, p. 10

172 Report by the Comptroller and Auditor General COMPASS contracts for the provision of accommodation for asylum seekers, Session 2013–14, HC 880 p. 23. Public Accounts Committee, COMPASS: provision of asylum accommodation, Forty-fifth Report of Session 2013–14, HC 1000, p. 11

174 Justice Select Committee, Transforming Rehabilitation, Ninth Report of Session 2017–19, HC 482, p. 3

Published: 9 July 2018