Our Blog

Third Sector | Is outsourcing the problem?

by Rodney Schwartz

Recent events at Carillion and Capita bring the question of public service outsourcing to the forefront. Many services have been outsourced despite observers questioning whether or not the taxpayer is getting good value for money from such relationships.

Even more galling is that when things work out well for taxpayers and badly for contractors, outsourcers are sometimes able to walk away without paying all their contractually-agreed penalties. Concerning the recent East Coast mainline case, for example, Andrew Adonis, former Labour secretary of state for transport, railed against what he has described as a bailout of Sir Richard Branson and Sir Brian Souter by the taxpayer. It is suggested that the contracts would have seen taxpayers paid hundreds of millions of pounds over the coming years by Virgin and Stagecoach.

Unsurprisingly, Labour’s leadership sees this as providing ammunition for its plans to gradually renationalise rail services. The argument that profit-oriented companies are ill-suited to run services where the wider societal benefit is a powerful one. Those of us interested in social impact, and enterprises which generate it, would obviously be partial to ensuring that more than shareholders benefit from such endeavours. But interestingly, shareholders did not win either. Carillion has gone into liquidation and Capita’s share price has tumbled from 1320p in 2015 to 197p recently.

So what is going on here? Who wins from all this?

I contend that two groups seem to win—company executives and today’s politicians. The former secure high levels of pay which are difficult to recover – shockingly, ‘clawback provisions’ for executive bonuses at Carillion were relaxed in 2016, a practice which has been severely criticised – and today’s politicians secure services their voters want, and the bill is paid for by future taxpayers. The cynic in me thus sees government and big business as co-conspirators in this escapade, and not opponents, as left-wing rhetoric aims to suggest. I do not believe nationalisation would secure a fair deal for consumers and taxpayers – I believe that the recipients of ‘spoils’ would change, but social impact would not be increased. Both politicians and business people have become adept at securing benefits in the short term at the expense of future generations.

This ‘intergenerational shafting’ is one of the great themes of our time. One can use this analysis to explain the crash as well. Bankers and traders secured rewards in the short term, but the consequences of their excessive risk were picked up by future taxpayers. Mechanisms which account for these hidden negative intergenerational externalities are difficult to devise.

One idea might be to require central and local government contracts to contain explicit elements of independent assessment of projects on a regular basis – or at completion, with penalties for under-achievement and bonuses if results exceed expectations, in both financial and impact terms. Thus, contractors could generate extra profits if they outperform clearly stipulated guidelines.

What is essential is that such evaluations include both financial, quantitative, qualitative and impact criteria. This would reinforce the provisions of the Social Value Act and ensure that help to ensure that the positive and negative externalities generated by firms would be internalised. Such a system would begin to favour impact-oriented enterprises – businesses and charities – which exist not only to maximise profits, but also to generate social, ethical and environmental benefits for society.

In the short term this may not have such a significant impact on the problem identified, but over time, if bonuses and penalties were disclosed, financial analysts and fund managers could start to draw conclusions about firms and their tendencies to play by the rules, or not. Those which consistently misbehave would find it harder to raise capital and probably harder to win contracts, whereas impact-oriented firms would find the opposite to be the case.

This is just an idea, and very rough. There are bonuses and penalties in contracts already, but the impact elements seem minimal and public disclosure is limited. Such disclosure would add to the market’s knowledge about how contractors behave, which might assist them in avoiding the next Carillion.

This blog was originally published on Third Sector on 20 December 2017.