Construction giant Carillion has collapsed. In 2014, Jonathan Derbyshire asked: are the firms that take on the government’s work just too big?by Jonathan Derbyshire / January 23, 2014 / Leave a comment
A mechanic in the north London workshop of Barclays Cycle Hire, a scheme operated by the outsourcing company Serco
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In a few weeks, the Cabinet Office will pass judgement on a “corporate renewal plan” from Serco. Many people will have hardly heard of the company that provides a bewilderingly wide range of public services, from “Boris bikes” to nuclear weapons. The Whitehall review may be couched in the language of management consultancy but the stakes are high, for Serco, for British taxpayers, and for a belief in how to run government that stretches back decades.
Shortly before Christmas, Serco announced that it had agreed to return £68.5m to the taxpayer. An audit carried out by the Ministry of Justice (MoJ)—which also examined “anomalies” in contracts held by one of Serco’s competitors, G4S—had uncovered systematic overcharging on its contract for “electronic monitoring” (or tagging) of offenders. In a statement, Serco accepted that these “contract issues… should never had happened” and apologised “unreservedly” for them. It also said it was confident that the proposals in its renewal plan would be “sufficient to restore the confidence of its government customer,” with whom it holds contracts worth £6.2bn. As well as being forced to reach a settlement with the government, Serco was now the subject of an investigation by the Serious Fraud Office. (The Ministry has also referred two G4S contracts for court services to the SFO. G4S noted that “the Ministry has no evidence of dishonesty in relation to these contracts.”)
This was not an isolated incident. Earlier last year, Chris Grayling, the Justice Secretary, referred Serco’s handling of another contract—for escorting prisoners to court—to the City of London police. It appeared that Serco staff had wrongly recorded the number of prisoners they were delivering. (The company has since agreed to make repayments on that contract too, although it still has the business after giving an undertaking to “improve performance.”) Nor were the dysfunctions restricted to Serco’s contracts with the justice department. A few days before it issued its mea culpa for the tagging fiasco, Serco revealed that it was withdrawing from an NHS contract to provide out-of-hours GP services in Cornwall. An investigation by the National Audit Office (NAO) published in March had revealed chronic under-staffing and regular manipulation of “performance data,” findings corroborated in a forensic review by the accountancy firm PricewaterhouseCoopers. Another review by the Cabinet Office of 28 major contracts held by Serco and G4S in eight departments, with a total value of £5.9bn, found significant “weaknesses” in the majority.
Responding to the PricewaterhouseCoopers investigation, Valerie Michie, Managing Director of Serco’s health division, said: “Serco is not complacent, but the company believes these matters are historic and there has been significant learning and action by the company since this time.” Margaret Hodge, the Labour MP, offered a rather acid gloss on this when Serco’s Chairman Alastair Lyons—it currently lacks a chief executive as the last one resigned in the autumn—appeared before the House of Commons Public Accounts Committee in November. “So what you are really saying,” Hodge suggested, “is, ‘we ripped you off in the past, but we won’t do so in the future.’”
At the very least, this record raises the question of whether the contracting out, or “outsourcing,” of public services to private suppliers offers value for money. For almost 30 years, successive administrations (and the Conservative-Liberal Democrat coalition is no different) have argued that outsourcing improves efficiency and keeps costs down. The recent intense scrutiny of government contracts has also usefully focused attention on the sheer scale of what the economist DeAnne Julius has called the “public services industry.” In size, Britain’s “industry” is second only to that of the United States. The NAO, which has carried out a review of the four biggest outsourcing companies (Serco, G4S, Capita and Atos), estimates that “contracting out accounts for around half of the £187bn that the public sector spends on goods and services each year.”
If anything, the pace of outsourcing has intensified since the 2010 election, driven, among other things, by the passing of the Health and Social Care and Welfare Reform Acts and the introduction of the “work programme,” a scheme designed to help the unemployed find jobs. When I spoke to Francis Maude, Cabinet Office Minister and de facto secretary of state for outsourcing, he insisted that the serial failures of the big suppliers of public services did not amount to “an argument for slowing [outsourcing] down.” On the contrary: “We just need to be finding better ways of doing things,” he said.
What a recent Financial Times editorial described as the “craze for outsourcing” dates back to the early 1980s, when the Thatcher government introduced compulsory competitive tendering for local authorities, who were required to open services such as construction, maintenance and highways work to private competition. This was extended to support services in the NHS and eventually, under the terms of the 1988 Local Government Act, to ground maintenance, refuse collection, libraries and arts centre management.
Perhaps the most explicit statement of the ideological assumptions underpinning the Thatcher government’s programme was given in 1988 by Nicholas Ridley, then Secretary of State for the Environment, in a paper written for the Centre for Policy Studies, the free-market think tank. Local authorities, he wrote, ought to be asking themselves the following questions: “How can value for money be best obtained? How can the needs of the public (consumer) best be served?” The answer in both cases was competition. “Inside every fat and bloated local authority,” Ridley declared memorably, “there is a slim one struggling to get out.” It is the job of politicians, he thought, to “assist in that struggle.”
Ridley’s analysis was heavily influenced by so-called “public choice theory,” which rejected the idea that there was any such thing as a distinctive ethic of public service. As his Cabinet colleague Nigel Lawson once put it, far from being the “selfless Platonic guardians of paternalist mythology,” public servants are a “powerful interest group in their own right.” With one important difference from other such groups: “While in the private sector persistence in failure is likely to lead eventually to bankruptcy or at least severe financial loss, the incentive for self-correction on the part of the state is very much weaker…” The sooner the disciplines of the market were introduced into the public sector the better.
In a similar spirit, the current government has made “diversity” a synonym for “competition,” one of the central principles of its public service reform agenda. Launching the white paper on “Open Public Services” in July 2011, the Prime Minister announced that diversity, by which he meant the opening of government procurement to “new providers and new ideas,” is now the “default in our public services.” Henceforth, he went on, the state will have to “justify why it makes sense to run
What Cameron didn’t say was that the state should also have to justify why it makes sense to run an oligopoly, to allow a small number of suppliers to dominate a particular area of public service provision, in the process deterring new market entrants with less financial muscle. However, his colleague Francis Maude made just this point in reference to government IT services in 2011. “For too long,” he said, “government has wasted vast amounts of money on ineffective and duplicate IT systems… We will end the oligopoly of big business supplying government IT by breaking down contracts into smaller, more flexible projects.” Maude admitted to me that many government contracts, not just those in IT, have in the past been too big, “which basically froze out small businesses.” The beneficiaries were behemoths like Serco.
Serco was first listed on the London Stock Exchange in 1988, on the crest of the original outsourcing wave. It was founded in 1929 as the British arm of the American electronics corporation RCA and became a separate company only in 1987, after a management buyout. Since then, it has grown dramatically, particularly over the past decade or so: in 2000, it reported total revenues of £630m; by 2012, that figure had risen to £2.7bn. Tom Gash, Director of Research at the Institute for Government and co-author of a report on “Choice and competition in public services,” points out that much of that growth was achieved through an aggressive strategy of mergers and acquisitions. The same is true of Serco’s main competitors. “What’s interesting about these companies,” says Gash, “is that they are very diversified. And that’s not something we usually associate with modern companies. Today companies tend to specialise and find the thing that they do best.”
What Serco and the others do best is win government contracts. As the academic Tony Travers put it in an appearance before the House of Commons Public Administration Select Committee in 2009: “There are now, because of successive governments’ policy, a significant number of companies that are, for want of a better word, ‘parastatal’: that is they only exist because the public sector buys services from them.” Of the big four companies reviewed by the NAO, Serco is the most successful at winning government business: while other outsourcing companies (including Atos and G4S) have bigger global revenues, today Serco receives more in revenues from the UK public sector than any of them. In 2012/13, its UK public sector revenues totalled £1.8bn, compared to £1.1bn for Capita and £0.7bn each for both Atos and G4S. Of that £1.8bn, £1.2bn came from central government, with £382m coming from local government and £201m from the NHS.
Unlike G4S, nearly half of whose public sector revenues come from a single source, the Ministry of Justice, Serco’s government contracts are distributed across 11 departments, as well as numerous local authorities. In addition to the Barclays Cycle Hire scheme and the Atomic Weapons Establishment (which it manages in partnership with Lockheed Martin and Jacobs Engineering), Serco also runs the Docklands Light Railway and provides maintenance for missile defence systems, security for the UK Border Agency, air traffic control and leisure services, as well as administering government websites.
This unusually wide range of interests and commitments is reflected in Serco’s distinctive corporate structure: Gash describes it a “federated model,” although “Balkanised” might be a better description—Andrew Brooke, an analyst at RBC Capital Markets, told the FT: “The group is made up of 800 disparate contracts run like individual companies.” Questioning Alastair Lyons at the Public Accounts Committee, Amyas Morse, the Comptroller and Auditor General, wondered if Serco’s “extremely rambling structure” might account for some of the well-documented contract failures: “Have you actually got the capacity to be in control of what is happening in the multitude of subsidiaries down below?” Lyons insisted that it is “perfectly possible for a broad, complex organisation to have strong controls… We have a basic framework of control, and we need to build on it.”
I put to Maude the suggestion that companies such as Serco have become too big for their boards to exercise proper scrutiny of individual contracts, and too big—that is, too deeply implicated in the complex web of public service provision—to be allowed to fail. “They are not necessarily too big,” he replied. “But one of the things Serco in particular recognises is that it needs to go through a period of corporate renewal and provide us with evidence that they are implementing a satisfactory plan to ensure that they do have proper control over what happens. We expect them to have a much better grip on how their contracts are being implemented.”
Both the NAO review and the Cabinet Office report on major contracts identified failures of oversight on the government side as well. Certain instances of overcharging, the Cabinet Office found, could have been avoided by more active management of contracts. Indeed, the Ministry of Justice’s own internal review, published on the day that Serco announced it was repaying the money it had overcharged for the tagging contract, found that officials tended to lose “focus” on what suppliers were up to after procurement and had also failed to properly assess the risks involved in certain contracts. Today, MoJ staff are actively ensuring that “suppliers are complying with their obligations” and, in the case of Serco’s contracts for transporting prisoners to court, are providing direct “administrative supervision.”
Similar shortcomings were found in other departments, failures of transparency and scrutiny that made it hard for government to establish whether contractors were actually delivering or if their profits reflected a fair return. The NAO report observed that the big companies’ accounts don’t separate out public sector work, which makes it difficult to see how much of their profits derive from government contracts. This is only possible where “open book arrangements” are written into those contracts.
“Accountability” was one of the five fundamental principles of the white paper on Open Public Services (the others were choice, decentralisation, diversity and fairness). In keeping with this, Maude says, “we now expect contracts to be available to public scrutiny. And we’re insisting on there being open book accounting on contracts. So far we think about a third of government contracts are open book. But we want to go much further.” Though not as far as agreeing to make those contracts subject to freedom of information (FOI) rules. Maude dodged the question when I asked him why the Prime Minister had not responded to three requests from the Public Accounts Committee to bring the suppliers into the ambit of FOI. Sunlight might be the best disinfectant, but only, it seems, in restricted doses. Richard Bacon, a Conservative member of the Committee, told the Daily Telegraph: “The people who are most reluctant [on FOI] are not the companies but the clients—the government departments. They fear that openness will reveal that civil servants have not negotiated good deals on private sector contracts, that their poor commercial capability will be exposed.”
Maude reminded me that a new government agency, the Crown Commercial Service, has been created with the aim of “professionalising” procurement and “building commercial understanding across the civil service.” “It will have responsibility for ensuring that commercial capability within departments is significantly strengthened,” he said. “At the moment, we have very large numbers of people who are doing commercial work, but they’re not all in the right place and are not all the right people. The reforms we’ve instituted so far saved £3.8bn last year. But we’ve got much more to do—we know that.”
That surely should include exploring alternatives to an outsourcing regime that has benefited the biggest players to a disproportionate degree. Maude agrees. “A model I strongly favour,” he tells me, “is one where we do what we call a mutual joint venture, in which the staff own a stake in the business, the government retains a carried interest and we sell a stake to a private sector partner. In that case, all the interests are aligned.” Whether Maude’s colleagues in the Cabinet are as enthusiastic about this radical vision is another matter. One suspects that Serco and its main competitors will be hoping that they are not.