After Carillion: Public sector outsourcing and contracting Contents

Conclusions and recommendations

How appropriate is it for public services or projects to be run by the private sector?

1.Government outsourcing is now more important than ever. This is true not only of the UK but also of most other advanced economies. The Government purchases almost as much from external providers as it spends on its own staff. There are few public services where the Government does not rely, to some extent, on some sort of contractual relationship. (Paragraph 14)

2.At different times, private, charitable and public providers have both succeeded and failed to contribute to successful public services. All the witnesses to our inquiry accepted that the public sector should buy in some goods or services from the private sector, and should insist on providing others internally. The public sector should not contract out the final decision making about policy. The public sector always retains responsibility for the entitlement of individuals to benefits or services. Whether ordinary services should be outsourced though will depend upon the capacity of the public sector, private sector or voluntary sector to deliver them, the comparative cost, and ultimately, the value that each provider can produce. (Paragraph 23)

3.There was a consensus among the witnesses to our inquiry that the Government should be taking a reasoned, evidence based make-or-buy decision. The Government has set out criteria for this in its Green Book guidance. This decision is not binary between private provision and public provision but should include a number of alternative methods of provision, several of which might involve commissioning the service or providing the service in-house. We heard conflicting evidence about whether the Government consistently follows its own guidance in this respect. It is impossible to tell from the outside whether decisions have been made appropriately. (Paragraph 30)

4.It is intolerable that the Government is spending £250 billion with little evidence that it is currently following its own procedures to secure value for money. The business case procedure set out in the Treasury’s Green Book provides a suitable basis for making decisions about whether and how to let contracts. However, we are concerned by the evidence of the Comptroller and Auditor General that this is not always followed. The Cabinet Office and Treasury should ensure that all contractual decisions are based on a sound business case and in accordance with the guidance laid out in the Green Book. (Paragraph 31)

5.Public trust in outsourcing has been seriously damaged recently. This is due to a number of high profile failures–including most recently the failure of Carillion. The Government needs to rebuild trust in the process by which it makes decisions about outsourcing. The Government can only achieve this by being transparent about how and why it decides to purchase a good or service. Especially in cases where private sector involvement or the type of commissioning is novel, the Government should publish its rationale for the decision and notify the relevant select committee. This might take the form of a published business case, for example. (Paragraph 32)

6.The Government must produce evidence about the advantages and disadvantages of purchasing from the private or third sector in different public services. This should include an assessment of the cost and quality advantages and disadvantages of purchasing services. The Government should establish a centre of excellence for research into applied contracting (for example, through establishing a new “What Works Centre”). (Paragraph 36)

The Private Finance Initiative: time for honesty

7.PFI financing costs more than government financing because the state can borrow at a cheaper rate than the private sector. While we are confident that PFI costs more than conventional procurement, neither we nor the National Audit Office nor the Public Accounts Committee can find any evidence of the benefits the Government claims for it. It is unacceptable that almost 30 years after the first PFI projects were initiated, the Treasury cannot produce an evidence base to support its claims that PFI is worthwhile for any reason apart from the fact that it takes debt off balance sheet. (Paragraph 45)

8.The Treasury and the Government should not approve any further PFI projects until they can clearly justify, based on evidence, their claims about the benefits of the scheme. It will seem bizarre to many observers that the Government has chosen to pay more than it could for £60 billion worth of projects, without evidence of any benefits from the extra cost involved in using this financing method. Ministers should be able to choose to use state finance where it is clear that private finance would bring no benefits. The Treasury should scrutinise in particular the recently approved transport projects (the A303 Stonehenge tunnel and roads and the £1.5 billion approach roads to the Lower Thames Crossing) to ensure that there is good evidence that private finance represents the best value for money in these cases. (Paragraph 46)

9.The Government should investigate the experience of the Scottish Government with the Non-Profit Distributing model and report back in its response to this report its view of what the UK Government can learn from the Scottish experience. (Paragraph 47)

10.The Government has previously maintained that it selected private finance only when it judged it to be value for money to do so. However both the comments of the Civil Service Chief Executive, and more importantly, recent changes to the Treasury’s guidance on refinancing make clear beyond a reasonable doubt that the Government’s true reason for using the Private Finance Initiative or PF2 is that the debt does not have to be shown in the National Accounts or within the national debt. (Paragraph 48)

11.Balance sheet treatment is not an appropriate justification for the choice of method of finance or for the terms of government contracts, especially if it means the contracts cost the Government more. We welcome the decision to clawback excessive profits from refinancing; however, it is wholly unacceptable that the Government have reduced this in order to conceal the true nature of public sector liabilities. The Government should note in their response that our recommendation follows similar arguments from both the Treasury Select Committee and the Public Accounts Committee. Without compelling evidence and justification from the Treasury, the Government should re-introduce refinancing provisions allowing 50% gain share for the public sector. (Paragraph 49)

The Government’s approach to contracting: managing risk

12.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. (Paragraph 53)

13.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. (Paragraph 63)

14.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. (Paragraph 64)

15.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. (Paragraph 65)

16.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. (Paragraph 71)

17.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. (Paragraph 75)

18.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. (Paragraph 76)

The effect of Government monopsony on the private sector

19.Some of the Government’s contractors developed unsustainable business models over recent years, underbidding for contracts, recklessly acquiring other businesses and maintaining high bonuses and dividends. For example, Carillion’s balance sheet, before its failure, was propped up with high risk construction contracts and high valuations of goodwill, arising from overpayments for acquisitions. The directors and shareholders of the companies involved are responsible for this. Share prices, buy, hold or sell recommendations and public statements are a poor guide to the long term security of companies. Shareholders can accept higher risks for an equity rate of return and can exit at short notice. Government is in for the long term and cannot take such risks with public money or with the security of public services. The Government as the major customer of these firms is responsible for the services they supply and consequently needs to ensure that its contractors are able to deliver those services sustainably. As Ministers are accountable for the resilience of services, they cannot be blind to the risks that the companies delivering those services hold. (Paragraph 86)

20.The Government should improve its due diligence processes to understand the resilience of the cashflow and financial position of its partners. In 2017, the Government still awarded contracts to Carillion despite the weakness of the company’s balance sheet on the basis of “quite detailed tests on the financial capability of Carillion”. The Government should urgently review its due diligence procedures on the contracts awarded to Carillion. The Government should commit to announcing its findings from this review in its response to this report. (Paragraph 87)

21.There is widespread agreement that contestability (the credible threat of competition) is important in order to support an efficient market for public sector services. Contestability motivates firms to improve services and cut costs and motivates the public sector itself in the same way. The combination of limited competition and high barriers to entry generates worse outcomes however for the Government. (Paragraph 94)

22.The Government needs to ensure that the market for Government contracts remains contestable from within the public sector, from existing companies and new entrants. We welcome the Minister’s commitments in this area and we await to see in the Government’s response details on its new measures to increase small and medium sized enterprises’ participation in the market. (Paragraph 95)

23.The Government should test the thesis that less competition (as opposed to contestability) also undermines outcomes for the public sector. This reflects a widely held consensus but it would be useful for the Government to commit in its response to commission further research. The Government should outline in its response to our report the detail behind the Minister’s commitment to a new playbook of guidelines, rules and principles. (Paragraph 96)

24.The Government made the right decision to let Carillion fail. The Government lacked confidence in the plans put forward by the company’s management. The cost of funding the company would have been higher than the costs of the liquidation. It is notable that the shareholders and financers of Carillion have lost money through the failure of the company. We agree with the Minister that this is appropriate as it sends a signal that ultimate responsibility for Carillion rested with its management, shareholders and financers. (Paragraph 109)

25.The failure of Carillion could have resulted in the collapse of public services. It did not. The Cabinet Office and the Government ensured through contingency plans worked on between July and January that they could cope with the liquidation. The Government deserves credit for ensuring that, in January 2018, services mostly continued. The Government were right to prioritise the interests of the public who use those public services. (Paragraph 110)

26.The Minister for the Cabinet Office has announced a review of how the Cabinet Office responded to the Carillion crisis. That review should take note of the weaknesses in the Government’s approach. These include the Government’s surprise that Carillion issued a profits warning in July 2017, when some investors had been warning about the state of the company for years. (Paragraph 111)

27.The Cabinet Office should ensure that it holds appropriate information about the contracts held by each of its strategic suppliers and aggregate the risk exposure from across the whole of Government to large contractors like Capita and Serco. We understand that the Public Accounts Committee will be reporting on this issue shortly and we await their recommendations with interest. The Cabinet Office should also ensure that it learns lessons from this crisis about how to quickly collaborate with local government to deal with the issues raised by a collapse such as Carillion. (Paragraph 112)

28.We welcome the Minister’s commitment to bring forward proposals for living wills with each key strategic supplier. The Government should lay out in their response to this report what these living wills will contain. The Government should clarify whether these wills would only apply when a contractor goes bankrupt, or whether they would also apply when a contractor withdraws effectively from a contract. The Government should set out measures to ensure that the public knows that these living wills are agreed: so that users of services can have confidence in their resilience despite what may or may not happen to particular companies. (Paragraph 113)

The Capability of the UK civil service

29.The Cabinet Office has invested significantly in commercial capability over the last few years. Outside observers have said that, since that investment, the quality of the Government’s commercial management has improved, albeit from a low base. We look forward to the recommendations of the Public Accounts Committee about the future development of the Crown Commercial Service and the Government’s commercial capability. We welcome the Government’s decision to invest in this area but we remain concerned. (Paragraph 124)

30.The Government must continue its efforts to improve its commercial capability. Currently, this capability is unevenly distributed among departments. The Government also needs to take care that it does not, through having better negotiating capability, merely drive harder bargains with the private sector based on unrealistic estimates of service quality and cost. The Government needs to move beyond such a transactional approach and develop its understanding of the market and its partners in delivering public services. The Government and its contracting partners should share and express the same values. The Government should set out in its response to this Report its future vision for commercial capability, including measures to encourage collaboration within the public sector and verified trust between the Government and its providers. This should include a new code of conduct which would apply to both Government and suppliers and set out expectations of behaviour and shared values. (Paragraph 125)

31.The Government needs to improve, as our predecessor Committee suggested, its understanding both of risk transfer and of costing Commercial skills cannot be seen in isolation from other skills. We believe that it is vital that staff with commercial skills work alongside staff with other skills such as costing, project management, IT and financial planning in letting contracts. They should also work alongside staff with deep subject knowledge and expertise. In its response, the Government should set out its plans to integrate together teams which have IT, project management, costing, financial planning and commercial skills and possess deep knowledge and expertise. (Paragraph 126)

32.The Government can only let and manage contracts successfully if it has the right data. The Government admits that it needs to improve its internal data. We are concerned by the fact that the Government has not systematically analysed where and how it spends taxpayers’ money on procurement. This includes data not only about current contracts but also about areas that the Government wishes to purchase in the future. We welcome the Government’s commitment to improving its data about contracts. (Paragraph 133)

33.We welcome the Government’s intention to publish a number of key performance indicators. We also welcome the comments from the private sector in support of this. The Information Commissioner is right to say that transparency is a key principle of democratic government. She is right to insist that, as more diverse models of service delivery develop, the Government should ensure that transparency is not lost. (Paragraph 134)

34.The Government needs to improve its internal information so that it can design, let and manage contracts more successfully. The Committee has made this point before in other contexts. The examples in this report strengthen the case that the Government needs to develop a full understanding of the services it provides to the public. The Government should set out in its response how its strategy to improve management information will tie into its commercial strategy. (Paragraph 135)

35.We understand the Government’s concerns about the implications of increased transparency for some smaller contractors, and such requirements should be proportionate. However, we think that the principle that Parliament and the public need to have key information about the delivery of public services is important. The Government should set out in its response to our report which key performance indicators it has decided to publish and its justification for the choice of those indicators. The Government should work with the Information Commissioner to ensure that revisions to the Freedom of Information Act address her concerns. (Paragraph 136)

36.We recommend that the Government should consult with the Local Government Ombudsman and the Parliamentary and Health Service Ombudsman about the problems identified by the Local Government Ombudsman in relation to complaints made about private sector contractors, over whom he has no jurisdiction. We agree with the overarching principle that all users of public services, regardless of who delivers the service, should have the right of access to an independent ombudsman. The Government has already published the Public Sector Ombudsman Bill in draft and this should be amended. (Paragraph 137)

Published: 9 July 2018