A house of cards – the failure of outsourcing

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A house of cards – the failure of outsourcing

The news that Interserve plc are in financial difficulties has cast doubt on the future of the Transforming Rehabilitation reforms and created further uncertainty among its workforce.

Interserve badges itself as the largest provider of probation and rehabilitation services in England and Wales. It owns 5 of the 21 CRC contract areas.  At the time of writing the company is reputedly worth approximately £19 million (market worth linked to share price) but has debts of approximately £700 million.

Whilst Interserve continue to win new contracts the size of them appear moderate and therefore unlikely to address the debt problem. Interserve is required to repay £50 million interest on its debts in April 2019 or potentially risk breaching its financial covenants with the banks. If it fails to do so it will be obliged to consider other options including, and most likely, giving the banks more (complete) control.

Interserve will probably survive but its current predicament – coming in the wake of the collapse of Carillion – raises further and fundamental questions regarding the political obsession with outsourcing public goods to the private sector. When the services they commission fail, politicians quickly distance themselves and present these as isolated incidences of poor management.

The government will no doubt continue to outsource services to the private sector claiming they deliver value for money. However, we believe that the failure of outsourcing companies, such as Carillion, are symptomatic of much deeper failures within the current system of service delivery. The scale and nature of outsourcing means that the market for delivering public services is dominated by giant conglomerates with similar business models that are heavily dependent on securing public contract revenues,  won by undercutting their competitors, and an unrelenting growth strategy accelerated through acquisitions. This has resulted in large and complex provider companies bidding for contracts and entering new areas of service delivery where they have limited or no history of expertise.

Such organisations operate like the proverbial ‘house of cards’ as the scale and diversity of their portfolios also means that problems in one area of the business can rapidly impact on other areas, putting a whole range of public services, workers and sub-contractors at risk. Neither Carillion’s or Interserve’s financial difficulties were directly linked to its government contracts. In the case of Interserve, its financial problems have been attributed to long standing problems regarding its involvement in energy from waste plants (EfW). Whilst it is undoubtedly the case that Interserve have lost millions on these schemes, to some extent it has become a convenient cover story. The sheer size of their debt will have many causes nonetheless the pain in terms of budget cuts and redundancies has been felt across all areas of the company including the CRCs.

Poor decision-making, over several years, we believe is the more likely explanation for the serious predicament that these companies have found themselves in. They also highlight a fundamental flaw in the UK’s corporate governance system. Carillion’s cash flow had been negative since 2012 but the company continued to pay increased dividends to its shareholders up until it was placed in compulsory liquidation. In effect its directors were using the vast loans the company accrued to shore up its dividends and mask the perilous financial state that it was in. It was an operating model based on bidding at low margins to secure contracts, squeezing costs through the supply chain and using high debt to post profits and secure a dividend for its shareholders.

Successive governments have colluded with such practices. They have deliberately pursued an aggressive approach to risk transfer to the private sector as “an appropriate response” to public spending cuts in a period of politically and ideologically-driven austerity.

Shortly after the transfer of CRCs into private ownership, a senior Interserve manager referred to how the company would use its ‘deep pockets’ of financial equity to transform rehabilitative services. Given its current financial position this statement now appears somewhat hollow.  The reality, we would argue, has instead been reactive cost cutting, permanent re-organisation, delivering a broad set of generic interventions rather than the promised innovation. Lamentable IT systems and punishing target based workloads, has delivered low staff morale and high rates of sickness and attrition.

In the case of the CRCs then, was a pup sold or a dud bought? At the very least it begs the question of the robustness of the due diligence that took place prior to the contracts for the CRCs being let in 2013. What incentive did the Conservative-led coalition government have to undertake this complex work when the wheels of privatisation were oiled and ready to run? Did those MoJ officials involved in the tendering process understand the financial viability of all the potential owners? Did they believe they would subsequently have to inject approximately £500 million into the coffers of the providers within the first three years of the contract?

Despite the on-going criticisms of Transforming Rehabilitation from a range of bodies including HMI Probation, the Justice Select Committee and National Audit Office, the government appears hell-bent of pursuing this failed model of service delivery. Will any lessons be learnt other than beefing up the contract areas?  Will the government develop a deeper understanding of the new owners supply chains and the risks involved beyond their published accounts and share forecasts? The least that can be expected is that the process for contract tendering will be more transparent than that which marked the original contracts but there are little grounds for confidence here. A quick resume of the timescales does not look promising with the draft operating model scheduled to be issued in January 2019 and due diligence undertaken and the contracts awarded just six months later.

This sounds painfully familiar to the letting of the original contracts, but the difference this time around is that the private sector want and need to reshape the financial aspect of the contracts. They have learned some awkward and possibly humbling truths. However the important factors for workers is that any operating model, will be sprung on staff as the tender document will not be shared with interested parties as it will be deemed commercially sensitive. Therefore, all the same problems, of providers over-promising and under-achieving, could and probably will resurface again.

By Lol Burke and Barry O’Doherty

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