Tuesday, September 27, 2011

Public contracting Vs in-house service delivery?

Conventional wisdom would have it that private contracting is more cost-effective than government in-house activity in that they deliver services with greater quality aand at cheaper prices. I have sought to provide a more nuanced perspective on the issue here, here, and here.

In this context, a first of its kind comprehensive comparative study of the cost of in-house government delivery versus private contracting by the Project on Government Oversight (POGO) in the US reveals several interesting findings. It analyzed the total compensation paid to both federal and private sector employees, and annual billing rates for contractor employees across 35 occupational classifications covering over 550 service activities to assess the cost-effectiveness of federal service contracting. The study writes,

"The current debate over pay differentials largely relies on the theory that the government pays private sector compensation rates when it outsources services. This report proves otherwise: in fact, it shows that the government actually pays service contractors at rates far exceeding the cost of employing federal employees to perform comparable functions.

Our findings were shocking — POGO estimates the government pays billions more annually in taxpayer dollars to hire contractors than it would to hire federal employees to perform comparable services. Specifically, POGO’s study shows that the federal government approves service contract billing rates — deemed fair and reasonable — that pay contractors 1.83 times more than the government pays federal employees in total compensation, and more than 2 times the total compensation paid in the private sector for comparable services... Federal government employees were less expensive than contractors in 33 of the 35 occupational classifications POGO reviewed... Private sector compensation was lower than contractor billing rates in all 35 occupational classifications we reviewed...

We believe awarding government service contracts is nearly always more expensive than having such work performed by federal employees, even after accounting for the total cost to the government of federal employee fringe benefits and associated overhead costs."

In simple terms, this effectively negates the widespread perception that contracting out service delivery will result in considerable savings. The argument that outsourcing or contracting will automatically result in competition and resultant efficiency improvements and tax payer dollar savings is questionable, certainly the later. As the study finds out - using contractors to perform services may actually increase rather than decrease costs to the taxpayers.

And about the reasons for this failure of governments to wring out better deals from private contractors than even the private sector,

"POGO found several failures in government procurement, employment, and data systems that limit the government’s and the public’s abilities to assess and correct excessive costs resulting from insourcing or outsourcing federal services. Failures included the lack of standards for calculating cost estimates and justifying insourcing or outsourcing decisions; the lack of data related to negotiated service contract billing rates; not publishing government information about the number of actual contractor employees holding a specific occupational position under any given contract; and that there is no universal job classification system."

Cost-effectiveness consists of two parts - efficiency improvements and cost of service delivery. Though, as the study shows, contracting fails on the later, it does bring in efficiency improvements. This does mitigate the higher cost of service delivery to some extent. But even with this, the cost of contracting remains far higher, as seen from the comparative study, for similar service delivery in private sector (where the efficiency improvements are less substantial).

This cost of contracting becomes even greater in developing countries where the cost of transacting with the government is substantial and a premium gets priced into the contract cost. This apart, the inability or limitations inherent in public contracting systems comes in the way of governments getting the best possible deal. Finally, there is the issue of inherent problems of co-ordination and resultant transaction costs associated with scale that applies to contracting certain public services. All these three problems are greater in developing countries, and therefore the premiums are higher.

None of this is an endorsement of in-house serive delivery or a case against outsourcing or public contracting. My objective is two-fold. One, it is important that we rectify the skewed public perception that private service delivery is inherently more efficient and cheaper than in-house service delviery. Second, a proper recognition of these deficiencies is important to help us design and implement outsourcing contracts that are cost-effective.


KP said...

Dear Gulzar,

I entirely agree with the analysis, and there are some additional factors that should be considered.

- When the government steps into a service, it could also be for capacity creation. In services like hotels as in your subsequent post - it may not be necessary.

- When the private sector creates capacity, they are also factoring the downside of the loss of the contract in the long term and redeployment of assets and resources - almost not in the scope of the government who are left with non-redeployable resources in most cases or inflexible capability to redeploy.

- at the lower levels, government is always a better and more secure paymaster, and the current squeze all you can private sector approach is one of the negative outcomes of efficiency.

- However, efficiency through cutting corners and a drop in service levels in the private sector will /should be compensated by the market response - lower business.

- Inefficient government services - the correction is between painfully slow and almost non-existent - and government managers are not concerned primarily with issues of service and profitability.

- take the case of infrastucture and an example of Border Roads - it may require capacity building / retention and governments own resources in view of security and specific terrain related capacity / secrecy etc.,

- In general the private sector could be better - ifff, the government has an organization capable of monitoring / regulation - with sufficient public oversight and transparency. However that is currently not the case if you look at the state of our roads - particulary post monsoon!. So private or public sector participation in areas like infrastructure can be equally shoddy work.

In India - I am not sure if a case can be made for public sector efficiency - unless it is an exception.

Public sector / public option as in the case of health care in Singapore is a fine example of what the government should be doing - holding the priceline by example without compromising quality.

Iam not sure if India has such examples, where the government sets the standard / bar for the private market - and by that, not the minimum tolerable level of service - when it decides to participate.

Beyond investment / infrastructure and salaries - I think in India the poor level of output / service / efficiency from government is always a question of culture.

But, without the capacity and the will to honestly regulate, particularly when the private sector is working on a public contract - the private sector can be expected to go down the same path of shoddy delivery - while in this case raking in profits at the expense of the deliverable.

regards, KP.

Richard H. Serlin said...

I've made similar comments from the perspective of an MBA and business owner:

"Project managers need to get used to the idea of working intensely with a development team rather than asking for a specific thing and then walking away"

A big part of the problem may be that over the last generation the Republicans' government is always bad message has dominated, so that, specifically for here, the idea has been subcontract out everything to the vaunted private sector.

But private businesses do not just subcontract out everything. They do a great deal in house. When I was an MBA student at the University of Michigan in the late 90s this was a big topic, when to subcontract out and when to do it in house, and the message was not subcontract out everything, it's always better. The message was there are pros and cons. Sometimes the subcontractor has specialization and core competence that you really don't, but on the con side, get too many subcontractors, and it can be really hard and expensive to manage, coordinate, and monitor this spider's web, and there were other cons too.

Because of a generation of right wing dominance, the government does way too much subcontracting out to the vaunted private sector, even when it's really hard and expensive to monitor, manage, and coordinate, or you're just creating unnecessary and expensive middlemen; a good example is direct student loans vs. through banks, which was vastly more expensive and complicated.

Referring to the quote above,the in-house personnel may be so hollowed out that there's not the manpower to do that...

...Also, I'm really disappointing that they didn't go all open source. So many people want this to succeed who would have helped. But again, another con with subcontracting out to for-profit private companies. The profit motive makes them less likely to like open source, which can create a lot of inefficiencies...

...Seriously, when you start subcontracting out crucial complicated opaque things, you end up having no idea what's going on, only the subcontractor does, and that's when they can really mess with you. We were really taught that lesson in Michigan's MBA program. But pros, cons, nuance, case-by-case, that's anathema to today's simple-minded dogmatic Republican Party.

At: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/21/the-way-government-does-tech-is-outdated-and-risky/?commentID=washingtonpost.com/236a4937-0c93-4d23-a20e-040d93cc6938/

I will be doing a post on this if you'd like to work on it jointly. I've had some success blogging, with about a quarter of my posts in the links of Economist's View and quoting by Paul Krugman, Ezra Klein, and others.