25 September 2012

The Confederation of British Industries (CBI) tells us that government can save over £20 billion pounds without affecting the quality of public service, simply through increased outsourcing. Does this sound too good to be true?

The data presented in yesterday’s CBI report on public sector outsourcing is fascinating. On behalf of the CBI, Oxford Economics examined data from a number of government organisations and identified the rough proportions of expenditure on contracts in a range of public services. We find out, for example, that 48% of hospital security spending is outsourced, compared to 47% of local government waste management services, 27% of schools catering, and 16% of police forensics. The numbers contain some assumptions – but probably amount to the best estimates yet on levels of outsourcing in these areas.

The headline estimate is underpinned by different sources – namely, estimates of outsourcing savings from the CBI’s own members. In each service area, these estimates are checked against other publicly available estimates. On average, the CBI estimate savings of 11% through contracting out – and this saving has been applied to the expenditure on ‘in-house’ services in areas that could conceivably be outsourced. This gets you the £22.5bn saving estimate.

The estimate could be on the low side. One of the benefits of outsourcing is that it can allow public sector organisations to focus on the things that they do best – leading to efficiency gains in other areas of their business.

But there are many reasons why the savings estimate is in fact likely to be too high:

1.A true estimate of savings from outsourcing should compare the CBI savings estimate with estimates by public sector organisations retaining their services in-house. Efficiency tends to improve over time – and this comparison would help clear up whether savings were due to outsourcing, rather than factors like technological advance.

2.The saving estimate assumes that all the expenditure in most service areas can be outsourced. The experience of IT outsourcing shows that keeping certain services in-house, particularly aspects of oversight and management, helps you understand the services you are buying and to remain an effective purchaser. Even advocates of outsourcing also recognise that one of its benefits is the creation of a competitive threat for in-house services. In-house options might sometimes deliver more effectively – as was found in past pilots of outsourced employment services, where JobCentre Plus outperformed private contractors.

3.The CBI estimate assumes that most services will be well suited to outsourcing. Some will be. But contractual arrangements generate design and oversight costs too and outsourcing only makes sense where these costs will be outweighed by performance gains. The Institute is developing criteria to assess the costs and benefits of outsourcing – and it is already clear that complex services are harder to outsource well. Organisations that outsource must also be able to transfer the risks of failure so that services that are critical to their mission cannot easily be contracted out. When Boeing found out that the company it had contracted to provide essential plane parts was failing it ended up buying the company at an inflated price to avoid catastrophic delays in production and damage to its reputation.

4.The CBI savings estimate also aggregates hypothetical savings in individual service areas. But what of the co-ordination benefits of maintaining services in one organisation? One lesson from history is that the wrong choice of outsourcing approach can undermine co-ordination. Local bus services have been largely privatised in most of England, with fees coming from end users (along with various subsidies). The approach is now being reversed in many because it resulted in falling bus passenger numbers and anti-competitive practices. In contrast, London’s (generally effective) integrated transport system outsources specific aspects of service delivery (bus routes, ‘Boris’ bikes, Oyster cards) but contractors are tightly managed by Transport for London.

5.Savings will only be realised if government designs and manages outsourcing arrangements effectively. Policy Exchange research has suggested that this isn’t always the case, revealing that government spends over five times the going rate for electronic monitoring. Clydesdale Bank has also announced it is bailing out a number of schools caught out by fraudulent IT companies who overcharged them.

All of these factors suggest that CBI’s estimates are aspirational rather than realistic. The report helps to highlight that all organisations should think carefully about whether they should provide services themselves or outsource them. But as well as considering outsourcing organisations need to thoroughly assess other models and their likely costs, benefits and risks.

Our report Commissioning for Success highlights that if government is to achieve even a small portion of the benefits pointed to by the CBI it needs to develop its skills and processes. Decisions about when to outsource need a more robust basis; monitoring and stewardship of outsourced services needs to be strengthened; and accountability arrangements also need to be clarified – as commissioners currently appear to face few consequences for failures on their watch. Effective outsourcing won’t happen by itself – and, counter-intuitively perhaps, will demand more of government, not less.