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Outsourcing: the risks of losing control

by Peter Harris
Should all council services be done in-house, or out-sourced? There is no automatic “correct” answer.

Delivering services in-house has intuitive logic. The Council can control the level, cost and quality of the services directly. However, outside providers may be able to do so at lower cost, hopefully because they are more innovative and efficient, but also perhaps because they pay lower wages, or trim back quality.

There is no presumption that out-sourcing services will cost less. In normal circumstances there is a cost “wedge” that has to be overcome. The external provider needs to make a profit and pay taxes on it. For the council, there are the costs of developing the contract, monitoring it, and dealing with variation and non-compliance.

The literature does not reach any predetermined conclusions. It depends on time, place and circumstance.

What the literature does identify is that there are risks with moving away from in-house provision. These risks suggest that good decision making considers the longer term, and does not simply compare a bid with the current cost of providing the work. This is because suppliers make loss-leader type bids to establish what is known as a “foot in the door monopoly.” It is difficult for rival bidders to supply a specialist service in case it is re-tendered at some time in the future. Competition keeps the provider honest, but the more specific the service is, the less likely it is that rivals will stay in the market. The most effective tactic the local body has to restrict leverage is to maintain a threat of taking the service back in house. This requires it to have some capacity to scale up, if a contract cannot be renewed satisfactorily.

Keeping capacity in house also helps monitoring and enforcing the terms of a contract. Finally, where volumes of future work are uneven and unpredictable, contracting is doubly difficult.

All of this is somewhat theoretical. But we can draw on the recent experiences of the Kaipara District Council. It got into financial difficulties and the Minister appointed a review team to look at it. The team’s report notes that a high degree of out-sourcing created a high degree of consultant capture, a loss of institutional knowledge and control of intellectual property, and left the council in a weak position to set policy and undertake planning and asset management. Note that the degree of outsourcing is an important contributor to weakening the position of the council.

The recommendations suggest that the interface between the council’s in-house functions and the out-sourced functions be reviewed to ensure that the council retains control of policy development, service planning, customer services and asset management. I emphasise the word control, because the key issue is how effective it is.

The team recommended that a service delivery policy (and here I emphasise the word policy) is developed that addresses:

. the need to retain core functions and intellectual property in-house
. the practicality of out-sourcing
. the costs of procuring and administering it, and
. the appropriate allocation of risks.

I leave the final words to the review team:

“Contracting out both the service delivery and the oversight of that work … is risky as there is a loss of control and institutional knowledge.”

Peter Harris is a long-term commentator on public policy issues. He made this presentation to last week’s extraordinary meeting of the Wellington City Council, before councillors voted to sack 27 CitiOps workers and out-source their street cleaning jobs.