Public Spending

The UK is only the latest government to announce massive spending cuts to reduce its huge budget deficit. Will procurement be able to play its part in delivering on the efficiency agenda?

 

Autumn 2010

 

By Peter Smith

 

In recent months the UK has witnessed probably the most dramatic political events for 50 years or more, culminating in the formation of the first coalition government since 1945. It’s a new government that seems determined to remake the landscape in education, health, social security and defence within weeks rather than years.

And while London has not (yet) experienced the unrest and industrial action seen elsewhere in Europe, this has important ramifications for public sector procurement, so it’s worth considering the major challenges and opportunities that will face the government. Also, what early indications has the administration given of its priorities in procurement terms? Procurement has a key role in most government initiatives and it must beware of certain traps.

Before the UK election on 6 May all the major parties appeared to be in denial about the state of the British economy and the budgetary reductions that would be necessary. Discussion, such as it was, focused on the need to cut ‘waste’, with the suggestion that this could be a relatively painless process. Now the debate has changed. Every department except those ring-fenced from cuts – health and international development – have been asked by the Treasury (the UK’s finance ministry) to draw up plans for savings of 25 per cent and 40 per cent. No one is now pretending that such large reductions will be easy or painless.

Even the relatively small spending reductions announced so far have obvious consequences. The government announced more than £6 billion of cost savings hot on the heels of the election in May. In October, George Osborne, the finance minister, is expected to announce a further £83 billion cuts in public spending. That represents about 14 per cent of the current outlay. If the ring-fenced areas really are excluded, the rest of Whitehall will face cuts of more than 20 per cent.

What can procurement contribute? About one-third of public sector spending is with third-party suppliers. Every pound saved through better procurement will contribute towards fewer cuts to jobs and services, so its role is paramount.

Inflexible spending
The first challenge for procurement is to ensure that, if staff numbers are cut by around 20 per cent, then the element of third party spend related to those people reduces by at least a similar amount. This is not easy. Few appreciate how large a proportion of administrative spend is inflexible in the short or even the medium term. There are private finance initiative contracts (often with fixed payments over 15 years or more); long-term outsourcing deals; and committed contracts in areas from legal aid to military equipment. All are difficult or impossible to cut in the short term, or at least not without contractual penalties or other consequences.

In some organisations at least 50 per cent of procurement spend cannot be quickly or easily reduced. This could lead to a situation where, in order to cut costs by 20 per cent, staff numbers may have to fall by a quarter because of the non-variable nature of much procurement spend. Such outcomes would be difficult, politically and administratively, and would certainly lead to questions about the effectiveness of procurement and whether it was making the contribution expected of it.

The second procurement contribution will come from a relatively straightforward source. Many programmes and projects will be cut or stopped altogether. Here, the challenge for procurement will be negotiating to minimise liabilities for contract terminations or major restructurings.

Perhaps most challenging though is where procurement must contribute to programmes that are based on different delivery models, for example, where strategies for engaging with the market may change dramatically. Sometimes this will result in funding reductions. However other programmes such as Welfare to Work (a work support programme carried out by the Department of Work and Pensions) may actually benefit from major spend increases – but in the private sector rather than the public sector and to achieve a reduction in the benefits payment bill.

In these cases, the role of procurement is to make sure policy objectives are achieved with the best possible value for money. These will not be simple cost-cutting exercises. High level commercial skills will be needed - the ability to shape markets, to understand commercial and payment options, and to build complex contracts that support the right supplier behaviour.

Meeting objectives
In these cases, it may be a struggle to measure procurement “savings” as such, since there will be no like-for-like comparisons to be made. Yet these are arguably the areas where top quality procurement management will be most vital if the government is to meet its objectives.

How achievable are the ‘savings’? The scale of the cuts needed in the public sector has been compared to those made by other countries, principally Canada. But commentators have pointed out that Canada made its savings when the private economy was booming. They were also implemented over a longer period than the UK government is proposing. Canada’s approach was also based on a fundamental review of the role of government. Until the results of the October Spending Review are known, it is too early to say whether the UK has followed the same lines. Departments are being encouraged to ask fundamental questions such as does the work need to be done at all? Or, does it need to be done by government? But the timeframes are very limited and ‘reforming public services’ is difficult to achieve in three months. So the outcome may be a more traditional ‘top slicing’ approach: reduce every budget by 20 per cent across the board.

The other problem is that the public sector cannot simply follow the path of the private sector: it does not operate solely on economic terms and cannot be wholly market driven. Dramatic cost reduction programmes are no strangers to the private sector. However these are often driven by the imminent collapse or bankruptcy of the organisation. In such cases, the decision may be to close factories or offices, move out of less profitable countries, or terminate product lines. This may all be classed as ‘efficiency’ in corporate reports, but it is harder for the public sector to mimic such moves. “We are pulling out of the North-East because it is too expensive and they don’t vote for us anyway” is hardly an option for the coalition!

Similarly, certain commercial decisions taken by private sector firms would not be acceptable in the public sector. Retailers with many suppliers highly dependent on them may be able to get away with demands for perhaps 2.5 per cent settlement fees but it is unlikely that government could take such an approach without challenges in the courts. And even retailers have to be aware of supply chain power - a small supplier may concede, but giants like Nestle, Mars or Unilever are quite capable of standing up to the biggest retailers. Similarly, while Microsoft, IBM or Siemens value their UK government business, it is hardly ‘make or break’ for them.  

Lack of formal contracts
Private sector firms also often run without very formal contracts, particularly for less complex goods or services, which makes negotiating or simply forcing through price cuts easier. The public sector is constrained by a more formal contracting environment. And changing the terms of a public contract to save money may trigger a challenge from another potential supplier, which could claim that, had the original tender been run with the revised specification, it might have won (see chart 1 for the public sector’s options and limits on its choices).

Having explored the feasibility of achieving savings what about the numbers themselves? As is the case in the private sector, savings are notoriously hard to pin down unless there has been a serious attempt to baseline at a unit price and item level. Procurement savings also follow other savings, to some extent. For example, if an entire factory closes or a product line is terminated, then logically fewer raw materials or less energy will be purchased and fewer machines required. But that is arguably not a procurement saving.

Equally, the savings are highly dependent on the market. Procurement teams buying electronic components in the past 20 years have been able to declare year-on-year double-digit savings because of technology-driven market movements. Achieving genuine procurement savings year after year in mature raw material markets, or service categories such as facilities management, is much more difficult.

Experienced practitioners suggest that, if all market, volume and specification factors could be removed, a genuine procurement savings target of 2-3 per cent a year (on both staff related and ‘other’ third party spend), is probably a realistic target. Interestingly, this is the sort of number that Sir Peter Gershon suggested as part of his Efficiency Review of the UK public sector in 2004. The Future Purchasing Alliance report Connecting Purchasing and Supplier Strategies to Shareholder Value found that although 78 per cent of large organisations had savings targets of above 2 per cent a year, but for the large majority of these the targets were between 2 per cent and 5 per cent. All of which suggests a note of caution is needed towards claims that savings (including from procurement) of 20 per cent or more will be easy.

So what has the coalition achieved in its first three months in terms of procurement and related issues? There have been some key organisational changes. The Office of Government Commerce (OGC), previously part of the Treasury and with an overall remit to promote procurement best practice across government, has been split. Its estates-related functions have moved to the Department for Business, Innovation and Skills, and the rest, including the trading arm, Buying Solutions, now sits in the new Efficiency and Reform Group (ERG) in Cabinet Office. ERG has a mandate to “ensure departments work together to quickly tackle waste and improve accountability”.

Following a review of all major projects, some high-profile examples have been terminated or drastically cut. So far there are four major government procurement initiatives being driven largely by ERG. First, the announcements in May included “immediate negotiations to achieve cost reductions from the major suppliers to government”. This is under way, but it is hard to see what levers the government can pull to extract reductions from some of the most powerful firms in the world. It may well be that negotiations will revert to individual departments, who seem to be better placed to drive savings from specific contracts.

Second, the purchase of a range of common categories will be aggregated for central government. This should be feasible and is likely to generate savings, although the amount of work involved should not be underestimated. Central government only accounts for about 20 per cent of the £200 billion annual procurement spend, so its impact on the overall budget will be small.

Third, a Home Office report in July on the police service suggested that forces would be obliged to use central contracts, so it might be against the law for a police force to buy uniforms, for instance, outside the approved national contract.  Use of contracts across the common categories (see Table 1, above) is also being ‘mandated’ across central government. This is uncharted territory for public procurement, and questions remain about how this will be implemented and monitored, and what sanctions would be taken against transgressors. It may not also sit easily with the new government’s overarching belief in localisation.  

Last, the government has made various commitments on transparency, including a number in procurement. They include publication of all contract opportunities over £10,000, and publication of contracts between government and suppliers. While this has undoubted benefits, it will also create considerable workload for procurement staff, and possibly some unintended consequences (such as an increase in legal challenges).

There will be huge pressure for savings in the public sector over the next few years, and procurement must deliver its fair share or the pain in terms of cuts in jobs and services will be even greater. However, there will be pressures on procurement; the transparency drive will lead to more bidders for each contract, more scrutiny and more challenge post-award; while EU procurement rules and regulations will remain a brake and constraint.

This may all make public procurement high risk, particularly for smaller organisations. One outcome is likely to be a boom in outsourcing, in the form of full business process outsourcing, at category-level through a vendor-neutral prime contractor, or as technology providers (such as e-sourcing specialists) take on more of the procurement work themselves.

The major initiatives described above, driven by ERG, would seem to have varying chances of success in terms of their contribution to procurement improvement and genuine achievement of better value. What is not yet clear is an overarching sense of the direction that public procurement might take or clarity of strategy, vision and purpose. That may well come when Ian Watmore is established as head of the ERG in the autumn. But because of its wider remit, of the 70 published initiatives that form ERG’s Structural Reform Plan, only 14 are “procurement” in nature. Others cover everything from shutting down quangos, to changing civil service terms and conditions of employment. It is therefore hard to see how Watmore is going to be able to champion procurement as strongly as did previous chief executives of the OGC.

Experienced and capable
Perhaps this does not matter. Many government departments have experienced and capable functional heads in place. But in the wider public sector, from non-departmental bodies through to local councils, health, education and emergency services, the picture is mixed: there are some excellent performing procurement people and functions but there are also organisations where poor practice is rife. To make matters worse, some of the bodies that have been driving procurement improvement, such as the Regional Improvement and Efficiency Partnerships, are themselves vulnerable to cuts or even closure.

At a time when procurement performance is critical for the public sector, the danger is that central government will become inwardly focused on its own “commodity” purchasing, while the wider public sector fragments with less focus and a lack of ownership of the goal of improving public procurement. It is early days for the new government, but much is riding on Watmore and his team at the ERG as it considers where public procurement needs to go next.