Supply Side
Sweden Wants To Cap Suppliers’ Profits – Why?

Most governments have to some extent embraced the idea that profit-earning (capitalist) firms can provide services to the public sector – even those that have in the past been delivered by the public sector. But now there seems to be an increasing mood of concern, even distrust, about the private sector’s motives and indeed performance.

In the UK, for instance, there is more focus on “open-book” mechanisms; understanding more about the supplier’s cost structures, profit margins and so on. The idea is that this will help in cases such as re-negotiation within the contract period, but it also plays to the feeling that suppliers should not make “too much money” out of government.

In Sweden, the centre left government has proposed taking this a step further. There has been a proposal to cap the profit that can be earned by firms engaged in delivery of certain welfare-related services on behalf of the government to 8%. As Reuters reported last week:

Shares in companies like healthcare provider Capio and school operator AcadeMedia have been under pressure since a leaked report in August that a government study would propose an inflation-indexed profit ceiling of 8 percent on invested capital for tax-funded welfare firms.

Investigator Ilmar Reepalu who will publish the investigation on Nov. 8 said a profit cap could be introduced without breaking any laws.

But what if the firm does other work for different clients? Will someone have to separate out the specific profitability for that particular contract? Or does it apply overall, which cannot be reasonable if the government work is only part of the firm’s portfolio. And if it really is “8 percent on invested capital” then that introduces a whole series of questions around how exactly one is supposed to calculate “invested capital” – a lot of work there for the big accounting and legal firms, we suspect (who probably make a whole lot more than 8% return themselves of course).

And there are other flaws. Would this not for instance simply encourage very profitable firms to pay their senior executives more to bring profit down just enough to slip under the 8% level? Or just to run inefficiently to bring down the margin – it surely cannot make sense to drive firms into a poorer level of performance?

It may well also be that this proposed law would be illegal under EU procurement and competition law.

“The foundation of EU is that everybody is treated equally. That’s not the case here when companies who make a certain profit can’t be part of a public procurement,” Andrea Sundstrand, assistant professor at Stockholm University, said. “Sweden cannot make up its own exceptions (to EU law), that has to be done in Brussels, together with all member states.”

It looks like the ruling coalition will struggle to get a bill through the Swedish parliament anyway. But while we may point out the flaws in this idea, it does indicate a tension in the public sector supply markets, not just in Sweden but in many other countries.

Few people disagree with the idea that private firms can help in the delivery of public services. Only the most extreme socialist or communist would argue that all drugs, or all food consumed in schools, or all construction work related to public buildings, should be performed by public employees. So there is a role – a key role – for the private sector.

But you do not have to be a Marxist to feel that sometimes, the more aggressive examples of capitalism do not sit easily with the public sector ethos. Whether it is some pharmaceutical firms increasing the price of drugs by thousands of percent, or tax structures that avoid firms paying tax in the countries whose governments are paying them substantial income, or firms deceiving buyers about contract performance, it is not good and does not look good to citizens.

Public procurement is at the heart of this. When we have clear and appropriate specifications and definition of requirements, truly competitive markets, strong and effective procurement processes, well designed incentivisation mechanisms, diligent and structured contract and supplier management, then we get good suppliers who will make a fair but not excessive return. And we will also get satisfied customers, taxpayers and voters too.

That is the mission of public procurement (in its widest sense) and what all of us involved in that field should be striving for – and if we succeed, then any suggestion of profit caps will surely disappear.