To deliver its policy objectives, the government often has to decide on the extent to which it should outsource provision of public services to the private sector. Although outsourcing can help cut costs, evidence from the pandemic suggests that it may not always be the optimal strategy.
The decision of whether or not to outsource particular public services is complex. The optimal policy for delivering resources – defined as the choice of service delivery and contracting strategy – varies according to a number of factors, including service characteristics, situational considerations and a number of financial, ideological and efficiency-related objectives.
The success or failure of a policy also depends on management, funding and staff capabilities. These factors are more important than whether or not a service is being delivered by the private sector. As a result, sourcing decisions should be made on a case-to-case basis, using past experience to help assure deliverability, affordability and value for money. Crucially, there is no single reason to outsource, and there are different types of outsourcing.
In the UK, the Outsourcing Playbook establishes a set of best practices that help address the challenges of ‘outsourcing’, which is defined as when an organisation decides to delegate the production of goods and services to an outside provider. This playbook means that sourcing decisions are, in theory, subject to scrutiny, ensuring that officials are accountable for the way they decide to spend public money. Such considerations are central in the context of the Covid-19 crisis, particularly in light of the high-value contracts offered to various private firms for medical supplies such as personal protective equipment (PPE).
How much do governments outsource their services?
In most market economies, a large share of public expenditure goes on procurement – ranging from 15% to 45% across OECD countries (see Figure 1). Healthcare, economic affairs (such as infrastructure, transport, communication, energy, and research and development) and education are normally the sectors with the highest share of procured services. As a share of GDP and government expenditure (11.8% and 29.1% respectively), the UK’s procurement spending in 2017 was slightly above the OECD average. But there are other high-income countries with much higher rates, such as the Netherlands, where 2017 procurement spending as a share of GDP and government expenditure stood at 19% and 46% respectively.
Figure 1. General government procurement spending as a percentage of GDP and total government expenditures, 2007, 2009 and 2017
Data source: OECD National Accounts Statistics (database).
Why do governments outsource some services to the private sector?
The rationale for outsourcing mainly concerns cost reduction and improved performance. The argument is that private organisations will be able to deliver services with wider social benefits including innovation and improved efficiency. These claims are made on the grounds that better incentives caused by acting within a competitive market make the private sector more efficient than state-run departments. But there are also concerns around the private sector’s strong incentives to engage in cost reduction and the lack of incentives to improve non-contractible quality. This trade-off could result in lower quality in outsourced services, especially when quality-reducing cost contracts cannot be controlled (Hart et al, 1997).
For example, outsourcing in support services in the UK – such as waste collection, cleaning, catering and maintenance – used to deliver large savings back in the 1980s and 1990s, often around 20% of annual operating costs. But more recent evidence suggests that these savings are now only 5% to 10% at best (Institute for Government, 2019). Nevertheless, it is doubtful that the public sector could carry on with the same levels of efficiency currently achieved without competitive pressures from the private sector.
Regardless of producing a certain service in-house (‘making’) or outsourcing parts of production or delivery to the private sector (‘buying’), it is important that the government is held accountable for the outcomes of its publicly funded programmes. The choice of the sourcing strategy is therefore a critical decision for public authorities.
In order to provide formal instructions for this decision, the Cabinet Office in the UK recently published guidelines on how to make resourcing decisions. The guidelines urge government departments to conduct a ‘delivery model assessment’ (also known as a ‘make or buy’ assessment) to capture relative advantages of different options using projected costs and benefits. Such directions discourage reliance on public or private sourcing on ideological principles and instead promote evidenced?based, analytical decisions.
A standard issue in outsourcing is mis-specifying cost factors associated with procurement. Transaction costs – the costs associated with setting, managing and evaluating an outsourced contract – account for around 8% of total delivery cost and they often get underestimated (Petersen et al, 2019; Flyvbjerg et al, 2013). These costs are not exclusive to the public sector and often hamper innovation. This is a critical issue in the UK given that its procurement process is much more expensive and time-consuming than the average for the European Union (Cebr, 2013).
As a result, an important question to ask when designing sourcing strategies is ‘how to buy?’ rather than ‘make or buy’. In deciding how to deliver public services, alternatives must be compared in order to choose the optimal strategy best placed to achieve pre-defined policy goals, while assuring deliverability, affordability and value for money.
How has the UK government sourced its services during the Covid-19 crisis?
On 16 March 2020, the prime minister asked leading UK manufacturers to produce vital medical equipment as part of the national effort to combat Covid-19. For example, firms in the engineering industry were asked to develop a critical care ventilator within 100 days (Gov.uk, 2020). These calls were met with a positive response by a number of UK manufacturing organisations (Confederation of British Industry, 2020).
The UK government has also engaged in partnerships with suppliers from other sectors on various projects, while easing regulations over procurement and data sharing. The argument was that this direct approach would help reinforce the mitigation policies designed to contain the spread of the virus.
Outsourcing in healthcare during the pandemic
It is argued that weakened and fragmented NHS services and public health departments hampered the UK’s ability to respond promptly to Covid-19, a situation that required instant acquisition of healthcare inputs (British Medical Association, 2020).
There are also concerns surrounding the transparency of processes. The National Audit Office – which acts as the watchdog for government spending – investigated government procurements during the crisis and found there had been a lack of transparency and a failure to explain why certain suppliers were chosen (Reuters, 2020). The investigation also highlighted a failure to examine how any conflicts of interest were dealt with. Of the £18 billion worth of procurement deals made between March and July 2020, £10.5 billion worth of deals were made with no competition.
It is common for governments to allocate a substantial share of procurement spending to healthcare services. Figure 2 highlights how the UK’s share of healthcare services procurement is almost the same as the OECD average. By way of a comparison, Japan and Germany’s share of health outsourcing is greater historically. Among OECD countries, the UK has one of the largest shares of healthcare financed through government schemes (Office for National Statistics, 2019).
Figure 2. Structure of general government procurement spending by function, selected OECD economies (2017)
Data sources: OECD National Accounts Statistics (database); Eurostat Government finance statistics (database).
Outsourcing in school meal programmes during the pandemic
In England, all infant state school pupils and children living in households on income-related benefits (with annual household income lower than £7,400 after tax) are eligible for free school meals. In January 2020, 17.3% of the school student population, accounting for 1.4 million children, qualified for free school meals in England (excluding year groups where eligibility is universal).
The free school meal programme was substantially affected by Covid-19. It is reported that 49% of eligible children in the UK did not receive any form of free school meals in the month following the first national lockdown (Parnham et al, 2020). There were also issues with the meal packages received by eligible households. Chartwells – one of the private companies outsourced to provide the meals – was accused of providing inadequate meals after parents shared images of the food they had been provided on social media.
Generally, outsourcing school meals may be problematic on several additional grounds:
- Nutrition: There is evidence that meals delivered by outsourced companies are of lower nutritional quality, which may have various health effects on the children who receive them. One report even found a correlation between cafeteria privatisation and lower test scores (Zullo, 2008).
- Economic savings: Some evidence suggests that hired private food service management firms spend less on labour (lower wages) and food (lower quality), but more on fees and supplies (McCain, 2009; MacDermott, 2010).
- Local economy: Outsourced firms in this market are usually linked with larger companies. This means that employing local labour and purchasing raw material from local markets is not a priority. In other words, public funding may move away demand from local food suppliers towards larger food companies.
- Subcontracted labour: It is common practice for the outsourced company to hire subcontractors for parts of the task. This could raise inefficiency in performance given that the introduction of new contractors adds to outsourcing complexities such as quality failure. It could also make monitoring, evaluation and verification more difficult.
In light of these issues, some schools decided to offer supermarket vouchers instead of outsourced meals. This alternative policy received positive feedback and could be replicated at a national level as a more effective intervention (The Independent, 2021).
How can the UK government improve the quality of outsourced services?
There is no single reason to outsource, and there are different types of outsourcing. If outsourcing is chosen as the preferred method of service delivery, there are still a variety of contracting types that could suit different circumstances.
For example, if delivering a specific ‘output’ or ‘outcome’ is the centre of attention for a public authority, some type of a ‘pay by result’ or ‘outcome-based contract’ might become an appropriate option. Such contracts lower the risks associated with asymmetric information (when a contractor is aware of information that the public authority is not) and misaligned motives (where contractor seeks payoff with lowest effort, but public authority wants delivery at lowest cost).
This could be achieved by directly linking payment to the success of pre-defined targets. In the case of free school meals, payment could be made contingent on verification of quality by the school, families or an independent party. A downside is losing sight on activities, which could allow further innovation or could lead to misconduct.
For four decades, successive UK governments have expanded the role of the private sector in delivering services – and there are many examples where the private sector has delivered high quality services at lower cost, and helped the public sector to become more efficient and innovative.
In deciding whether to continue to outsource or to bring services back in-house, neither option should immediately be dismissed. Each instance should be considered on its own merits. Public authorities should compare alternatives based on the evidence and find the best possible delivery model.
Finally, switching to other forms of contracting could be a helpful way to achieve better value for money. Outcome-based approaches and/or ‘pay by result’ contracts could strengthen public authorities’ stance on outsourcing issues. But such approaches are not the gold standard and may only work in specific contexts. To decide on the optimal type of sourcing strategy that best serves the policy goal, better guidance and frameworks based on solid analysis is essential.
Where can I find out more?
- The Outsourcing Playbook: This was conducted by the Cabinet Office initially in 2019 and sets out a range of guidelines along with a framework to assess the service delivery options.
- Government outsourcing: when and how to bring public services back into government hands: A report by Tom Sasse and colleagues at the Institute for Government on make or buy assessment.
- Investigation into government procurement during the COVID-19 pandemic: Report by the National Audit Office, the official watchdog on spending in the UK.
- Public-private partnerships: Lessons from COVID-19: A report by the CBI on cross-sector partnerships during the pandemic from a private sector angle.
- Government Outcomes Lab: A research institute with a strong policy focus, which studies outcome-based contracts, effective partnership and impact bonds.
- Centralisation versus decentralisation: the disastrous confusion at the heart of Britain’s approach to coronavirus: this Imperial Business School report by Carol Propper and Nelson Phillips reviews the funding strategy and organisational success of the UK’s coronavirus response.
Who are experts on this question?
- Mehdi Shiva, Blavatnik School of Government, University of Oxford
- Stéphane Saussier, Sorbonne Business School and Blavatnik School of Government, University of Oxford
- Mara Airoldi, Blavatnik School of Government, University of Oxford
- James Magowan, Department for Digital, Culture, Media and Sport
- Eleanor Carter, Blavatnik School of Government, University of Oxford
- Henrik Jordahl, Research Institute of Industrial Economics
- Clare FitzGerald, Blavatnik School of Government, University of Oxford