Section 2

Context

2.1 Outsourcing and commissioning

2.1.1 Definition of outsourcing

There is no generally accepted definition of outsourcing. For the purposes of this guide, it is defined as having the following four characteristics:

• ■an organisation (the ‘client organisation’) purchases services from a third party (the ‘supplier’)
• ■the client organisation has previously performed the services itself
• ■the services are provided for a specified period under a contract between the two parties
• ■the supplier is responsible for managing the services on behalf of the client organisation.

This definition excludes:

• ■the purchase of goods, such as stationery
• ■the supply of utilities, such as water, gas and electricity
• ■the commissioning of works, such as construction or refurbishment of an office building
• ■the purchase of services on an ad hoc basis, eg advice from consultants relating to a specific issue or project
• ■other purchases of services, eg legal or accountancy services, where there is no transfer of management responsibility.

The suppliers of outsourced services to public sector organisations include private sector organisations, voluntary organisations and other public sector organisations.

2.1.2 Commissioning

In recent years, the term commissioning has been increasingly used in relation to public services in the UK, often in connection with outsourcing. It is a general term that is applied to supplies and works, as well as services, and covers the whole process of defining requirements, identifying the best methods of meeting them and ensuring they are met. Outsourcing is one delivery model that may be used to meet requirements.

The Deanne Julius report (see section 2.3) defined commissioning as:

… the process which defines strategic outcomes and seeks to create relationships to ensure these outcomes are delivered … it covers everything from defining the objectives of a particular procurement, the formal bidding process, project implementation and post project monitoring and evaluation.

Commissioning therefore has a broader meaning than outsourcing; it is best understood in terms of a public sector organisation’s role as a commissioner, as distinct from a provider, of services. The part of the organisation that is responsible for commissioning (the ‘client’) may commission services from various providers, including other parts of its own organisation, as well as well as from third parties. This only counts as outsourcing where a contract is let to a third party for services that the client organisation has previously performed itself.

2.2 Development of public sector outsourcing in the UK

Public sector outsourcing is not a new phenomenon. Colin Cram, an expert on the subject, gives an example from about 100AD, when the Roman army occupying Britain outsourced pottery making to a local manufacturer. However, it is only in recent decades that outsourcing, both by the private and the public sectors, has become prevalent in the UK and elsewhere. While the USA has been at the forefront of this development, the UK has followed closely behind.

Outsourcing of public services in the UK began on a significant scale in the 1980s, when the government under Margaret Thatcher introduced compulsory competitive tendering (CCT) in local government. This was rolled out incrementally and was first applied to services that were provided using mainly manual labour and that were relatively easy to specify. At the time, many local authorities were hostile to outsourcing and so the introduction of CCT caused tension between central and local government. Table 1 sets out the services covered by CCT.

Table 1: Roll-out of CCT across different services

Authorities were required to expose all their existing work for each manual service to CCT, but only a percentage for each professional service.

The NHS and Community Care Act 1990 and certain government policies at the time, such as restrictions on capital expenditure, resulted in local authorities in England transferring care homes to the voluntary and private sectors and outsourcing care services generally. Since then there has been a massive shift in the way local authority funded home care has been provided, with the proportion provided directly by local authorities falling from 95% in 1993 to 8% in 2014. The shift in the pattern of provision of residential care, where the voluntary sector has always had an important role, has been less dramatic, but still very significant. The proportion of local authority funded residential care provided directly by local authorities fell from approximately 27% in 1996 to 4% in 2014, although the reduction was partly a result of changes in methods of providing care, rather than being due simply to outsourcing.

In 1992 the government launched the private finance initiative (PFI). Although the main purpose was to get public construction projects delivered on time and within budget, the PFI model also required the supplier to provide facilities management services, such as security and cleaning; where such services had previously been provided in house, therefore, PFI included an element of outsourcing. The model was initially used by central government departments and the NHS; in October 1996 it was extended to local government through changes to the capital finance regulations. The PFI model is described in section 5.6.5.

The Labour government, elected in 1997, abolished CCT and replaced it with a ‘best value’ regime. By this time the idea of private sector involvement in the provision of public services was becoming more accepted and many local authorities that had not previously done so were outsourcing services voluntarily.

The Labour government also embraced PFI and took steps both to provide more funding for construction projects to be delivered through this model and to remove blockages in the market. PFI soon became the main method for procuring new school buildings, as well as prisons, hospitals, defence establishments and waste management facilities.

The Labour government was clearly committed to extending the role of the private sector in the provision of public services, but the advent of the Conservative–Liberal Democrat coalition government in 2010 marked a new phase. In July 2011, the government published a white paper on open public services, which was announced in a speech by Prime Minister David Cameron; he signalled that public services would be opened up to competition except where there was a compelling case for the state to remain a monopoly provider.

The Health and Social Care Act 2012 reorganised the NHS in England with effect from 1 April 2013 and introduced clinical commissioning groups (CCGs). It has encouraged, and to some extent required, the outsourcing of clinical services. The regulator, Monitor, has the power to intervene if it considers that commissioners are acting against patients’ interests in restricting competition. Opinions differ about the long-term impact of this on the proportion of NHS expenditure spent on outsourced services. The results of a survey by the British Medical Journal (BMJ), published in December 2014, showed that of 3,494 contracts awarded by 182 CCGs since they came into being, 55% were awarded to NHS providers, 33% to the private sector and 12% to the voluntary sector and other providers. However, further evidence, based on a smaller sample who provided information about the value of the contracts in question, indicated that those awarded to private sector suppliers tended to be smaller, accounting for only 5% of the total by value.

Table 2, published by the BBC as part of a report about the BMJ investigation, shows that the proportion of the NHS budget spent on commissioning private sector suppliers increased only from 5.5% to 6.1% between 2012/13 and 2013/14.

Table 2: Proportion of NHS budget spent on commissioning private providers

Source: BBC News website, 10 December 2014

Recent developments in the organisation of state-funded schooling in England could be seen as a partial outsourcing of education provision. A large proportion of secondary schools and a significant proportion of primary schools are now academies or free schools. Their governing bodies are appointed by trusts, rather than by the local authority, which means that control of them is transferred to voluntary sector entities. While they remain subject to intervention by central government in certain circumstances, this could be seen as analogous to the client’s right to terminate under an outsourcing contract if the supplier fails to perform or becomes insolvent.

One step that the UK government has not yet taken towards the outsourcing of education is to allow state-funded schooling to be provided at a profit. Local authorities and/or central government could let contracts for voluntary and private sector providers to manage existing schools, provide state-funded places at independent schools and set up new schools funded and regulated by the state. This would be highly controversial, but in the light of recent developments in the social care and health care sectors, it is not difficult to imagine it happening.

The onward march of public sector outsourcing in the UK is confirmed by a survey of 267 local authority chief executives carried out by the Local Government Chronicle, in partnership with the Hay Group, in 2014. This showed that 51% expected that their authorities would outsource more services in future and 58% said their authority was moving towards being a ‘commissioning council’.

At the time of writing, shortly after the general election of May 2015, it is not yet clear how high a priority outsourcing will be for the new Conservative government. It can be expected, however, that the new government will continue to drive forward the open public services agenda set out in the White Paper of 2011.

2.3 Size of public sector outsourcing market in the UK

In 2008 the government appointed Dr Deanne Julius CBE to carry out a review of the public services industry in the UK. As part of the review, Oxford Economics was commissioned to carry out research. Using data from 2007/08, they estimated that the annual value of the industry in terms of turnover from outsourced public services was £79bn. With the UK population at the time standing at about 61.5m,1. this was equivalent to about £1,285 per capita. The report also estimated that the industry accounted for 5.7% of GDP and employed over 1.2m people. Furthermore, it estimated that in the previous 12 years the industry had grown from £42bn to £79bn in real terms.

The figures in the Deanne Julius report are broadly consistent with estimates that Oxford Economics produced for the Business Services Association in November 2012. These were based on data from 2010 and showed that the annual value of outsourced activity was £72bn for the public sector, compared with £126bn for the private sector. Public sector outsourcing represented nearly two-fifths of the value of all public sector procurement, including goods as well as services. The figures in the report imply that the public sector outsourcing market accounted for around 3% of GDP and employed around 4% of the workforce at the time.

Both of the above sets of figures are consistent with those contained in a report The Role of Major Contractors in the Delivery of Public Services published by the National Audit Office in November 2013, which was based on data from 2011/12 and 2012/13. This estimated that the total public sector spend on goods and services with third parties was £187bn and that around half of that was for contracted-out services, implying a value for the latter of about £93bn.

The estimates based on the three reports are summarised in table 3.

Table 3: Annual value of outsourced public services in the UK

The Oxford Economics report for the Business Services Association also provided a breakdown of public sector outsourced activity. This is replicated in table 4.

Table 4: Breakdown of public sector outsourced activity in the UK

Source: UK Outsourcing across the Private and Public Sectors (report by Oxford Economics for the Business Services Association, 2012)

The National Audit Office report focused on four of the biggest suppliers of outsourced public services: Atos, Capita, G4S and Serco. Figures in the report indicated that in 2012 these four companies accounted for about £4.3bn of total public spending on outsourced services in the UK, which was about 5% of the total.

2.4 International comparisons

The Deanne Julius report stated that the UK’s public services industry was second only to that of the USA in terms of absolute size. An appendix to the report, based on research by Oxford Economics, provided a comparison of the proportion of GDP which the public services industry constituted in selected countries. These figures are replicated in table 5.

Table 5: Public services industry as a proportion of GDP in selected countries

Source: The Market for Public Services: International Comparisons (appendix by Oxford Economics to Deanne Julius report, Department for Business, Enterprise and Regulatory Reform, 2008)

A report published by the Organisation for Economic Co-operation and Development (the OECD) in 2011, Government at a Glance, provided a comparison of ‘expenditures on general outsourcing’ by the public sector as a proportion of GDP for OECD member countries. It showed that in 2009 the UK had the third highest proportion (approximately 13%) after the Netherlands and Finland, compared with an average of 10% for all member countries. These figures, which include goods as well as services, are broadly consistent with equivalent figures in the appendix to the Deanne Julius report.

2.5 The successes and failures of outsourcing

2.5.1 The limitations of evidence

It would be useful for policy makers and practitioners to have reliable evidence, based on comprehensive statistical analysis, about the effects of outsourcing, including the frequency of successes and failures and how the performance of outsourced services compares with that of similar services under in-house management. However, as in many areas of public policy, it is extremely difficult, and probably impossible, to obtain definitive evidence of this kind. Decisions about outsourcing must therefore be based on a common-sense judgement, taking into account the client’s particular circumstances, lessons learned from the client’s own experience and from elsewhere and the alternative delivery options that are available.

While it is essential to learn lessons from other outsourcing projects, clients should be sceptical of claims that are made about the successes and failures of such projects because:

• ■clients, suppliers and advisers all have an interest in claiming that the projects they have been involved in have been successful
• ■outsourcing is a highly controversial and politicised issue and even researchers and commentators with no axe to grind are subject to bias
• ■a straightforward before-and-after comparison does not necessarily show the impact of outsourcing, because what is assumed to be an effect, positive or negative, of outsourcing may be due to other factors
• ■there may be a trade-off between cost and quality, so that an improvement in one is accompanied by a deterioration in the other and vice versa, making it more difficult to determine whether there is a net benefit
• ■failures may be due to weaknesses in the client organisation and/or the drafting of the contract rather than a problem with the principle of outsourcing.

There are numerous factors that may make a simple before-and-after cost comparison invalid including:

• ■changes in demand for the service
• ■changes in the quality of the service provided
• ■legislative and regulatory changes that affect the cost of providing the service.

While it may be possible to isolate the effects of any one of these changes, it is likely to be difficult or impossible to make a proper assessment of the impact of outsourcing where there are multiple factors at play, which is invariably the case in the real world.

Claims about savings achieved under outsourced arrangements are sometimes exaggerated because:

• ■some or all of the savings are due to external factors, such as a reduction in energy prices, rather than to anything that the supplier has done
• ■costs outside the contract, including the cost of procurement and the cost of managing the contract, are ignored or underestimated
• ■they are based on the contract price at the time the contract is signed, but for various reasons – including claims by the supplier for additional costs and client variations – this may have increased significantly by the time the contract ends.

Benchmarking – comparing the cost of the outsourced services with the cost of similar services provided elsewhere – is in principle a good way of judging the success of an outsourcing arrangement, particularly where the primary objective is to make savings. However benchmarking is fraught with difficulties because:

• ■third parties are often reluctant to provide information and may cite commercial confidentiality as a reason for withholding it
• ■where information is obtained from third parties, there is no guarantee of its accuracy
• ■while the scope of services provided elsewhere may be similar, the specification, performance standards and other contractual issues that affect price may differ markedly
• ■there may be good reasons why the cost of providing a particular type of service varies between client organisations.

Another measure of the success of outsourcing is user satisfaction. This can also be unreliable because:

• ■the framing of questions is difficult to get right and affects the results
• ■response rates may be low and therefore the respondents may be unrepresentative of end users generally
• ■respondents are often influenced by extraneous factors, such as their overall attitude to the organisation or to the principle of outsourcing
• ■it is inherently more difficult to achieve a high level of user satisfaction for some types of public service than for others.

That is not to say that the evidence should be ignored, but that a healthy scepticism is needed when drawing conclusions from the data and the claims made by others. Judgements about the success of an outsourcing arrangement are more likely to be accurate if they draw on evidence from a variety of sources, which may include before-and-after comparisons, benchmarking and user satisfaction surveys.

2.5.2 Claims about the overall success of outsourcing

The Deanne Julius report included a review of the academic literature on the benefits achieved from tendering public services. It stated:

The evidence shows that there are clear benefits, to both users and taxpayers, in subjecting incumbent service providers to competition. The academic literature typically found the cost savings from competitive tendering to be between 10 per cent and 30 per cent (including when the in-house team won the bid) with no adverse effect, and sometimes an improvement, in service quality.

However, the report acknowledged that this referred mainly to research based on the early experiences of contracting following the introduction of CCT. It quoted the following sources:

• ■a report by Domberger et al in 1987, which found that costs in the health sector were reduced by ‘as much as 34%’ by introducing competitive tendering
• ■a report by the Confederation of British Industry (CBI) in 2003, which showed that the prison sector had experienced cost savings of over 20%
• ■an Australian Industry Commission report in 1996, which showed savings of 10%–30% across sectors
• ■similar results from more recent UK experience in contracting alternative providers of medical services.

A report published by the CBI in September 2012 showed that savings ‘from productivity improvements generated by competitive pressure’ in a sample of public sector outsourcing contracts averaged 11% and ranged from 10% to 20%. The size of the sample, at £24.5bn, represented a considerable proportion of the entire public sector outsourcing market.

The Deanne Julius report and the CBI report are cited here because they both attempt to provide an overview of savings achieved from subjecting public services to competition. However, for the reasons set out above, the conclusions of neither these reports nor those of other researchers or commentators can be considered to be compelling. The Deanne Julius report itself acknowledged that the evidence it cited was out of date. Since both of these reports were published, outsourcing has continued apace; in organisations that have already outsourced considerable proportions of their services, the ability to achieve further savings without compromising quality may have diminished.

2.5.3 Critiques of outsourcing

The Institute for Government has produced a number of publications that provide an analysis of the reasons why various outsourcing initiatives in the UK have failed, or have not been as successful as they might have been, and which recommend how improvements could be made to current and future commissioning and outsourcing arrangements. These publications are written from the standpoint of a think tank promoting more effective government and do not take sides in the debate for and against the principle of outsourcing.

Challenges to the prevailing assumption in favour of outsourcing have come mainly from trade unions, campaign groups and independent researchers. A report by the Association of Public Service Excellence (APSE) for the trade union Unison, published in 2011, argued that the belief that private contractors are cheaper and more efficient than the public sector is misplaced. It provided a number of case studies where, it claimed, local authorities had achieved savings and improvements in quality through bringing services back in house.

APSE, which is a not-for-profit membership organisation working with local authorities, has also produced its own publications arguing that assumptions about the benefits of outsourcing should be challenged.

Social Enterprise UK, a campaigning organisation with a ‘vision of a world where social enterprise is the usual way of doing business’ has also published reports critical of outsourcing, particularly the dominance of a small number of large companies in some areas and a lack of transparency and accountability.

These publications are a useful contribution to the debate; they show that outsourcing is by no means guaranteed to deliver benefits, that markets do not always develop in a way that serves the public interest and that central government has sometimes made mistakes in the way it has pursued outsourcing. What they do not do is prove that outsourcing is generally contrary to the public interest, nor do they purport to do so.

Criticism of the way outsourcing has been pursued in recent years by the UK government is by no means confined to those who might be expected to be hostile to outsourcing in principle. In January 2015, following Circle’s withdrawal from its contract to run Hinchingbrooke Hospital in Huntingdon (see the appendix), John Tizard, an independent strategic advisor and commentator who was a senior executive at Capita from 1997 until 2008, called for a wide-ranging inquiry into public service outsourcing. ‘The worst possible government response would be to continue to contract out, outsource and franchise without any lessons being learned from events in Huntingdon’, he said.

2.5.4 The cross-government review of 2013/14

In November 2013 the National Audit Office published The Role of Major Contractors in the Delivery of Public Services. It referred to several high-profile allegations of poor performance, irregularities and misreporting in the preceding months. This followed the Ministry of Justice’s discovery in July of that year that there had been significant overbilling in its contracts with G4S and Serco for electronic monitoring of offenders. This and other high-profile cases, including accommodation for asylum seekers and the cancellation of the West Coast rail franchise competition, resulted in the initiation of a cross-government review of contract management.

As part of the review, 73 contracts were examined; 343 out of 5842. areas of contract management were assessed as weak. The results are detailed in a further National Audit Office report, published in September 2014. Table 6 gives a summary.

Table 6: Results of 2013/14 reviews of central government contracts

Source: Transforming Government’s Contract Management (National Audit Office, 2014)

The report identified four root causes of poor contract management by central government:

• ■failure to recognise the value of contract management
• ■senior managers not taking contract management seriously
• ■senior managers not demanding visibility over their contracts
• ■government having a permanent disadvantage in commercial capability.

The report also found that the issues that had prompted the review were similar to issues that had been identified previously, notably in reports published by the National Audit Office in 2008 and by the Public Accounts Committee in 2009.

The problems that were identified in 2013 occurred despite previous reforms, such as the establishment of the Office of Government Commerce in 1999. It remains to be seen if further reforms following the review, such as the establishment of the Crown Commercial Service in April 2014, will achieve the desired improvement.

2.5.5 Examples in the appendix

The appendix provides summary information about the contracts mentioned above and other public sector outsourcing contracts that have experienced difficulties or attracted negative publicity to varying degrees. They provide useful lessons that may assist practitioners to achieve success in their own projects, whether they opt for in-house, outsourced or alternative solutions.

2.6 Examples of services being brought back in house

Despite the general trend for public sector organisations in the UK to outsource more and more, there are numerous examples where services have recently been brought back in house.

The survey of 267 local authority chief executives, referred to in section 2.2, while showing that 51% expected to outsource more in future, also showed that 16% expected to bring more services back in house.

The City of London (see the following case study) is one example of a public sector organisation that has brought a service back in house because circumstances have changed since the original decision was taken to outsource.

In recent years there has been a trend for housing management to be brought back in house from arm’s-length management organisations (ALMOs). This has occurred in local authorities ranging from London boroughs to small district councils. The reasons for this trend are many and varied, but include the decline of the Decent Homes Programme, the completion of objectives set for the ALMOs, a desire to reduce overall costs, and duplication and changes in political control. A few new ALMOs have been set up, however, and many of the 69 that remain have long-term agreements with their local authorities, who are outsourcing other housing services to them, such as homelessness and waiting list management.

It was reported in Construction News in November 2014 that an increasing number of providers of social housing had been bringing housing repairs and maintenance back in house. Examples cited of organisations that had done so were Islington Council and two housing associations: Peabody and One Housing. The factors mentioned as having influenced these decisions were:

• ■financial pressures
• ■consolidation among suppliers
• ■dissatisfaction with the performance of suppliers.

The advantages and disadvantages of in-house solutions are discussed in section 3.5.3.