People & Skills
Favourite Articles of 2016 – Suppliers Lose Money, Has Procurement Done A Great Job?

Over the Christmas and New Year period, we will be featuring a daily favourite article from each month of this year (2016), which should take us nicely up to January 8th when we assume everything kicks back into gear! Today, a discussion about what good procurement looks like and whether suppliers have to make a profit out of public contracts.

Today, we have an important philosophical point to make about public sector procurement. It is this. If a public sector buyer puts in place a contract that once up and running sees the supplier losing a substantial amount of money, yet is continuing to deliver the service and meet the quality type standards, does that mean the buyer has done a brilliant job? Or does it indicate a poor procurement that did not fully understand the appropriate cost structures for the supply side, and has ended up with a situation that might be unsustainable?

This has come up because of the dreadful financial results announced last week by G4S, one of the largest providers of outsourcing services to government – not only in their UK base but in other countries too. G4S recently told a UK political committee (the House of Commons home affairs select committee inquiry) that it was paid an average of only £9.35 a night to house each asylum seeker. That was determined through a competitive process run by the government department responsible for this work, the Home Office. G4S is understood to incur costs at least 30% higher for each individual it looks after.

Serco, which currently houses 14,300 asylum seekers, also told MPs that they were paid £300 a month to house each asylum seeker but were spending £450 a month – so were making a loss of £150 a month per person. Serco made a provision in their accounts of no less than £115m for future losses on its asylum housing contracts.

That has happened perhaps because of the lack of experience amongst the providers when they bid to carry out this sort of work. Clearly, they misjudged the costs. The property boom in some areas of the UK in recent years cannot have helped either, pushing up the market prices of rental accommodation. But you have to think that there was some serious mis-pricing by the providers. If they are indeed losing money on every case, then the other problem has been the growth in numbers. It sounds like the contract means they are forced to accept however many asylum seekers appear.

Now usually, more volume would be good news for a supplier – more revenue plus some economies of scale on the cost side. But there are few economies in the business of sticking people into rented houses, and if you are losing money on every person, then more volume is very bad news indeed. It is also reported that the Home Office has the right to extend the contracts for another two years, so ironically we have suppliers here desperately hoping that their customer does not extend the contract! And there are apparently penalties in place and contractual conditions that mean the providers can’t just put the asylum seekers into tents somewhere.

Recently, John Manzoni, the Civil Service CEO and top civil servant in the Cabinet Office, gave an interview where he suggested that civil servants should be able to judge whether a provider was working inefficiently, or whether they deserved more revenue because something outside their control had occurred (that was our interpretation anyway). You can read more detail on that here, but might this be a case in point?

But surely there would be uproar if the government just handed over some more cash to G4S and Serco because they are losing money? And if they were rewarded, would any of the unsuccessful bidders from the initial competition complain about that as well? So this case shows the difficulty of Manzoni’s idea. What we have here is a combination of suppliers’ failure in costing and financial planning, probably overly aggressive bidding, plus some unforeseen events that are outside their control (volume, property costs).

But coming back to our starting point. Did the Home Office procurement team do a great job here? They put in place a contract where the supplier has accepted a lot of risk, by the look of it; performance risk, inflation risk, volume risk. The buyer is protected in the contract against the supplier trying to down-grade the service to reach profitability, and against the supplier just walking away it seems.  And the providers have stuck with it, up to now at least, so there have not been any issues around continuity of service. OK, so the providers are losing money, but the taxpayer has benefitted at the expense of G4S and Serco shareholders.

Whilst the situation looks uncomfortable, particularly for the suppliers, and it may well prove unsustainable for much longer, at the moment we say yes – it is a “well done” to the procurement team at the Home Office!

Voices (6)

  1. Peter Stuttard says:

    ” ‘Well done’ to the procurement team at the Home Office!”.

    Public sector procurement is, on far too many occasions, a complete farrago, and this article illustrates one aspect of the mind set that leads to that situation. Too often public sector procurers treat niche and specialist services as commodities, driving the price down to the lowest possible level, abusing their position as a monopsony. Good for the tax payer you could say? But even a cursory examination will reveal that this is not the case. Companies, even very large ones like Serco, do not have some secret source of cash, that £150 of loss per person per week has to come from somewhere. There is, ultimately, only one source for these monies, they come from the customers, and I wonder who Serco’s biggest customer is? Consider also that they will be scrimping and saving now, offering a minimal level of service, and there will be no money for reinvestment in training, people and infrastructure etc.
    Any sensible organisation strives to work in partnership with their suppliers, contracts should be fair and equitable, in the medium to long term this is the most cost effective approach. Such a simple concept seems to be beyond the wit of many in the field of public procurement, all to frequently they allow large suppliers to walk all over them, providing appalling services or products at outrageous cost, or in this instance, at the other end of the spectrum, they are congratulated for driving a company into a serious loss making situation. This is not good management, it is not effective, it is not professional and it is morally indefensible.

  2. bitter and twisted says:

    Serco are big boys with big pockets. If they signed a bad contract, tough. The shareholders will just have to suffer. That’s capitalism for you.

  3. Les Mosco says:

    An interesting debate. In my 35 years of contracting, I felt most ‘guilty’ about a contract I’d negotiated and signed with a big player who’d expected an expanding market, but we knew it would contract severely, leaving them with significant downsizing costs. I never lied to them on any question they asked, but I didn’t volunteer the truth if they didn’t ask. In the end, it worked for us, they took the financial hit, and provided a good service throughout. But I still wonder if I should have been more open, with the possible consequence of, at best, higher costs and liabilities for us, at worst them never signing the contract at all?

    In other cases, I’ve argued that I’m not bothered by loss leaders, so long as the goods/service aren’t ones where I need continuity of supply and contractor. So if my stationery supplier offers prices that are unsustainable, I think that’s their problem, not mine. But if it’s a critical service, where loss of the supplier would be disruptive for my organisation, then one needs to be much more thoughtful. So, is the government right to extend G4S and Serco’s loss making contracts? For the next 2 years, the tax payer benefits and the shareholders carry the loss. Sounds good but what happens on the next round of tendering? If it’s just as simple as the same players will still bid, but at higher prices, that’s OK. But if this deters future bidders, down to none or perhaps a monopoly, not good for taxpayers. If the Home Office have thought that through and concluded they will be OK, then we can perhaps congratulate them. But if they haven’t, it’s just short term ‘slash and burn’.

    1. bitter and twisted says:

      And what happens on the next round of tendering if the government do pay more now?

      Do you think Serco will cut their margins out of gratitude?

      And if you cant get the private sector to bid for something, I think thats the markets way of telling you the public sector should do it.

  4. Les Mosco says:

    I’m no a;pologist for the private sector, and if Serco are making a loss, I shed no tears. And I agree with you that if the private sector don’t bid, then the it’s probably telling you that the public sector should do it. But in many cases outsourcing has gone too far, in the public sector often driven by political idealogogy that private sector must be better at delivering than public sector. Maybe, but not necessarily, that’s why its important to stop and think. On your first point,I don’t expect ‘paying more now’ will create supplier gratitude, but forcing through a 2 year contract extension that is causing a significant loss, may mean that in the next tendering round suppliers walk away. So long as the procurement team have considered that possibility and satisfied themselves on its likelihood and consequences, then OK, but if they are simply screwing the supplier without thought of the end game, that is shortsighted and not good enough.

  5. Digby Barker says:

    It seems to me that this is an example of the more challenging type of decisions we have to make in life: how to strike the best balance between ‘competing’ objectives in the absence of shared assumptions about many of the relevant factors such as the timescale over which ‘best’ is to be considered…..