Monday 11 March 2019

Interserve is the latest outsourcing crisis

The interaction of Government, Government bodies and private sector outsourcing is one of the most interesting conundrums of recent years.

In the scheme of Brexit, this is merely a small tick. However, in another world, the near collapsed of Interserve, following on from Carillion a few months ago and Melrose of a couple of years ago would be bigger news.

The are two main interesting bits to see, one is the cause and the second is the cure.

The cause in the main is public sector procurement being led by strict rules on pricing. Only the lowest bids will win and it is not in the interest of Local or National Government officials to change this. So what we get is the new entrant cost-price game. Experienced companies are forced to compete with crazy new entrants for another classic of this case, take the Ministry of Transport offering a contract to a Ferry company for Brexit that had no Ferries. New entrants without experience will often hugely underestimate costs and are financed to survive this, or at least think they can.

In the short term, this has held Government procurement costs down, however in the long-term it has really undermined the outsourcing businesses that play in this space. Many, in a desperate bid to survive, have bid too low for contracts. As a result, we are seeing a string of re-financings and lender taking hold of the businesses. The Government, if it wants to avoid constant crisis, needs to change its procurement guidance such that it assures providers will survive and can indeed thrive.

The second interesting piece is what Government lawyers have done to mitigate this unfolding disaster. They have implemented 'Living Wills' so that services and contracts (read sub-contractors) will continue even as the parent goes bust above in the corporate structure. This is great for the much needed services, but another huge red flag for the Listed Entities, as now there is even less incentive for the Government to help and debt holders can seize the company in what is effectively a Government backed Pre-Pack administration. So much for shareholders, Management will do just fine in the circumstances. So whilst this is clever for the Government, it will actually undermine the sector further. Interserve will no doubt follow this path come the decision day on Friday of this week.

My own take is there is no way the Public Sector can deliver on the huge range of services the Government needs at a reasonable cost, so Outsourcing can be a good strategy and deliver economies of scale not possible in the Local Government sector. Increasingly though what we are starting to see is 'Public-Private' vehicles where Public contracts are run on private lines by Public sector companies that try to achieve the balance between public ownership risk levels and private endeavour and enterprise. This will be a solution Lefty (read all) Governments will jump on and will work just fine until they discover the ease for which corruption and graft can be embedded within these hybrid vehicles.


Elby the Beserk said...

The problem is that there is, never was, and never will be people competent in government to deal with this; indeed, W.C. Fields was looking way forward to this problem when he said

"Never give a sucker an even break".

We've been suckered. Again and again.

Even better, we get to pay for being suckered.

Brilliant. Fantastic.

Devil's Kitchen said...

“Only the lowest bids will win...”

This has not been the case for many years at the level that we operate (NHS, Housing Associations; contracts £20k–£250k (so far!)). Contracts are awarded on the basis of Value for Money, and scored via a ratio usually based, I admit, on the lowest price.

Our company is almost never the cheapest, but we do offer the most features, and so tend to win: whilst not the lowest price, we offer the best value for money.


Raedwald said...

Underbidding has been a headache for the construction industry for many years, but these service contracts are a bit more complex.

When Blair abolished compulsory tendering it was replaced by a 'best value' regime that allowed quality as well as cost factors to be evaluated - but for all public bodies covered by the EU procurement directives, this had to be applied in certain ways. Thus it was possible to award a contract on a basis of 50% cost and 50% quality so long as this was part of the original contract info.

I had some experience with service contracts back in the days when a long contract period - typically 7 years - allowed what appeared to be low value contracts to become very profitable from the second or third year onwards. This depended on the annual uprating mechanism and the pricing of variations and additions. One example is a school faclilities management contract - the staff taken over on TUPE were reduced by half within 3 years because we actually sacked them for excessive absence, something already in their contracts that wasn't previously applied, then we gradually reduced input hours to sites by 10% a year. And there was always stuff they forgot to put in the original contracts; once we charged £2k a year for looking after the school hamster during the Summer, something one of the old dinner ladies used to do. Ah, good days. We all did quite well out of it.

But old chums who stayed in FM are now out; the sector is dead. Minimum wage, London Living wage, low inflation, low costs of equipment and materials, loss of 'imperfect knowledge' and market frictions that offered competitive advantage, a low unemployment economy and yes, since 2016 a crap £-€ exchange rate unattractive to Eurolabour have made service contracts untenable.

We'll see several more failures.

The real solution is not attractive; high unemployment, high inflation, a chinese trade war, protectionism and the collapse of the Eurozone will revive the service sector and bring back the decent money rewards.

CityUnslicker said...

DK - you have done well then, my direct experience is that depending on what they are doing they can skew the marking so that the price is still more than 60% of the overall scoring, thus lowest price wins.

Raedwald - correct! indeed the improvement of procurement from the Government side in terms of costings has been to the detriment of the supplier side as efficiency has gown too much....funny how the world works out..

Anonymous said...

So the argument appears to be that bidders inefficiency should be subsidised rather than allowed to fail from their own incompetence.

Sounds like an argument a bank might use.

andrew said...


I have reason to believe that the real 'coining it' comes if the contract is renewed.

Some of the cannier outsourcers (say they) are focusing on trying to make a profit over trying to maximise turnover.

CityUnslicker said...

Anon - no, banks have lots of customers, most of the outsourcing has one in the form of the various bits of government.

Anonymous said...


I have to disagree. Any competent CEO would spread the risk or at least take out an assessment/hedging. Governments are no worse a client than anyone else.

Failures as described are no more than gross stupidity / too much risk / not understanding the market. Again something a bank would do.

Let the market decide and stop underwriting incompetence.

PS I may have strong feelings about this area having suffered at the hands of those who believed they would be bailed out - but weren't.

CityUnslicker said...

Anon- fair enough, outsourcers are full of chancers and charlatans as the rest of industry. My main point in the new creation of public/private companies won't be a solution, but a new, possibly bigger problem.

Anomalous Cowshed said...

TYR on outsourcing and contracts;

A back of a fag packet thought experiment, iterated over time, shows that the first few firms to successfully bid for contracts have an advantage over those who are unsuccessful, and then drop out of the bid process. The winners become focused on winning and administering contracts; the subbies face ever lower rates for doing the work, in exchange for security of payment.

It seems that government outsourcing acts to drive market rates down for individual subbies, yet individual (non-government) buyers represent higher volatility income streams, so notionally, they should be charged more, for the same service. The response to higher prices in this situation is to demand the lower price by shifting the responsibility for delivery onto government.

So the initial contract winners can win more contracts, but become increasingly divorced from the local conditions for each contract. The response is to place more and more formal conditions into each contract, increasing the complexity of each.

Poison's in the dose. With enough, very large firms are faced with managing wildly over-formalised agreements. Subbies are unable to respond to local conditions without reference to the contract. Administrative costs swallow an ever larger percentage of the revenue; at scale, wage growth slows while local innovation halts. The system is brittle; a single external shock is systemic.

Devil's Kitchen said...

True. It is rare to see price being more than 40% these days (at least in our kind of contracts).