Foundations of public outsourcing

Marcel Boyer

Foundations of public outsourcing

• Public and private decision makers’ conceptions about public-private partnerships have dramatically changed lately

• New economic theories enable the analysis of organizational or institutional designs in contexts where there exist:– Complex interrelationships between various parties– Incomplete information structures (different parties having

private information)– A willingness to enhance performance through organization

reforms (coordination and incentives)

The prosperity of a society is based on the quality of its

institutions/organizations• The prosperity of a society, its efficiency and its capacity to adapt to

an ever moving environment is strongly linked:–not only to the quality of human (education) and natural resources–but also to the quality of its institutions.

• The essential role of institutions and organizations is to: –organize cooperation and coordination of decisions made by large

numbers of agents –motivate those economic agents to fully contribute to the mission

(value maximizing, goal attainment) of the organizations/institutions –that is, to use the resources and the information at their disposal in

the most efficient manner.

Institutional Design

PRINCIPAL

AGENT

Regional Specific Context

Techno-economic Characteristics

Constraints• Information• Transaction• Administrative and political

Performance ofinstitutions

EfficiencyEquityImputabilityEconomic Development(regional)

PublicMonopoly

Public-corporate management

Delegated Mgt. Concession Privatization

Options

Principal-Agent Model

InformationAsymmetry

Divergent Interests

OPPORTUNISM

Social Objectives

• A high performance institutional arrangement achieves in a cost efficient manner the core objectives (adapted to the specific task or project considered):

– Efficiency

– Equity

– Imputability

– Regional economic development

given the transactional and informational constraints.

Objectives: Efficiency

• Static and Dynamic Efficiency– Absence of spoilage, minimization of costs– Maximization of social wealth – Standards must be established, respected and verifiable

• Allocating a resource to its best economic usage.

– Long term Investment in:• Capacity building, innovation, R&D, quality improvement

• Eco-efficiency - Global sustainable development

Objectives: Equity and Imputability

• Equity - user-payer

- direct redistribution rather than indirect taxation and subsidies: accessibility but no cross-subsidization

- stand alone cost (CORE)

• Imputability - the protection of the public

- open and transparent bidding

- incentives for long term decisions (intergenerational equity)

- level and extent of political delegation of instruments

Objectives: Economic development

(regional)– Knowledge and capability building

(core competencies)

– Business opportunities and job creation

– Efficient provision of business and social services (infrastructure)

– Network economies, Economies of scale, Economies of scope

• Productive efficiency requires the minimization of costs and the allocation of resources to their best economic usage.

• Allocative efficiency gains can be made from cost reflective pricing (or tarification).

• Productive efficiency can be separated from the pricing of public goods and services.

• Prices can be regulated by an independent regulator through a wide range of regulatory instruments– Ramsey-Boiteux pricing– Price caps for costs control– Global price caps in Networks– Rate of return regulation– Yardstick competition

Delegated Management and efficient/optimal pricing

Types of Delegated Management

vs. Characteristics

Public

Service agreements

Lease, affermage

Franchise,Concessions

Privatization

short term perpetualRights

Limited

Extended

limited partial completeextensiveDelegation none

long termperpetual

None

Private sectorcommitment

•Ownership•Financing•Risks•Operation

Delegated Management and Regulation

- base pricing

•Incentive regulation - cost overruns

- productivity gains

•Cost plus regulation (ROR)

•Price-cap regulation (RPI - X + Y)

•Menu of contracts

Incentive power of pricing schemes

HIGH POWERED(firms keep all gains from reduction of costs)

• Fixed fee or fixed price cap

• Price cap with revisions every N years on the basis of yardstrick performance

• Price cap with expectation of revisions on the basis of cost

• Expected (ex-ante) cost + rate of return fixed for multiple years

• Expected (ex-ante) cost + rate of return revised every year

• Actual (ex-post) cost + rate of return

LOW POWERED(firms keep none of the gains from reduction of costs)

Source: adapted from Jones (1994).

Examples:

Designing contracts for public-private partnerships:

Different clauses different compensation

• liability & control sharing

• risk management and sharing

• cost sharing

• conflict resolution

Designing contracts for public-private partnerships:

Liability and control / Information

strict liability

strict, joint and several liability

extended liability

capital structure

limited liability

incentives for care and diligence

Designing contracts for public-private partneship:

Risk management (integrated)

* Choosing a risk-return combination

risk management

ressource management

* Sharing risk

- risk aversion / tolerance- risk pricing

risk

return

Delegated Management and Cost Sharing

Multiple public - one private partnerships•Principles - fairness / equity

- coherence

- efficiency

- cross-subsidies

•The Shapley-Shubik approach

(incremental costs)

•The sequential cost sharing approach

(heterogenous needs and demands)

Designing contracts for public-private partnership:

Conflict resolution

• Inserting the process in the contract

• Exchanging information / arguments

• Third party arbitrage

• Residual rights owner

- value and pricing

Choosing partners in public-private partnership:

Competitive tendering (public and private)

• Multiple steps auctions

• Multiple criteria selection

• Open bidding rules

- participation conditions

- open access to information

•Dynamic incentives and opportunism

•Contract renewal procedures

Delegated Management and Performance Incentives

• Principles - informativeness

- intensity of incentives

- equal compensation

- intensity of monitoring

- ratchet

• Benchmarking / Scorecard

• Auditing process

Role of the public partner (municipal)

•Core competencies

- identifying public needs

(broker of citizens interests)

- arbitrage between needs

- managing contracts for maximal social value creation

•Time horizon and incentives

The role of the private partner

• Core competencies

- technology use and development

- economies of scale and scope

- development and export of know-how (human capital)

• Reputation building: Dynamic incentives and opportunism

Delegated Management of Municipal Services in Canada:

The CIRANO Survey

• # of municipalities surveyed

• # of questionnaires returned (filled by General Manager)

• 71 activities in 10 categories

• For 8 major activities,

-questions on the following characteristics: independence, complexity, standardization, uncertainty specificity

-questions on the importance of core (field, municipal business) competencies

-questions on the definition and verification of performance (cost, quality)

-questions on contract renewal procedures stipulated in contracts

Delegated Management of Municipal Services in Canada:

The CIRANO Survey

•For 8 major activities (suite)

-questions on contract management procedures and use of municipal assets and employees

-questions on problems encountered during the contract

-questions on investment financing

- questions on flexibility, economies of scale, pricing (tarifs)

•Perceived advantages (suggested list of 13 elements) and disadvantages (suggested list of 13 elements)

•Data on the municipality (size, area, assets, income and expenditures, taxes, debt, percentage of unionized employees, etc.)

Table 1: The top ten contracted out activities(% performed by outside contractors)

_____________________________________________________________________________________________

Activities Percentage Number of respondents______________________________________________________________________

Construction of buildings 89.0 296Recycling 79.2 269Legal services 77.9 321Refuse collection 70.6 302Engineering and architecture 69.0 290Burial of waste 67.7 266Development of IS applications 65.1 280Street lightning 60.5 307Installation of sewers 59.3 292Caretaking 46.3 325

Table 2: The bottom 10 activities being contracted out

(% performed by outside contractors)______________________________________________________________________

Activities Percentage Number of respondents

______________________________________________________________________

Secretarial services 3.49 346

Permits and licences 5.92 333

Billing and collection 6.27 347

Accounting 6.51 347

Tax collection 7.55 323

Human resources 1.90 339

Road signs 11.07 330

Suplies 11.30 327

Fire department 13.17 330

Archives 14.28 315

Table 3: The ten activities for which outsourcing

intentions are the highest (in %)_____________________________________________________________________________

Activities Percentage Number of respondents

_____________________________________________________________________________

Ice rinks 10.4 269

Development of I.S. applications 9.6 281

Snow removal 8.5 331

Caretaking / security 7.6 327

Sewage treatments 7.5 266

Refuse collection 7.3 301

Road maintenance and repairs 7.2 332

Management of SI-related activities 6.5 294

Water supplies 5.9 271

Recycling 5.5 273

Table 4: The ten activities for which outsourcing

intentions are the weakest (in %)_____________________________________________________________________________

Activities Percentage Number of respondents

_____________________________________________________________________________

Fire department 0.6 330

Supply 0.9 331

Permits and licences 1.5 334

Secretarial services 1.7 346

Accounting 1.7 346

Strategic planning 2.2 323

Legal services 2.2 323

Human resources 2.4 339

Tax collection 2.5 323

Archives 2.5 317

Table 5: The ten top activities for which outsourcing

would be most profitable (in %)_____________________________________________________________________________

Activities Percentage Number of respondents

_____________________________________________________________________________

Refuse collection 21.3 301

Caretaking 18.0 328

Engineering and Architecture 18.0 295

Development is IS applications 17.2 279

Ice rinks 17.2 268

Building maintenance 17.0 342

Construction of buildings 16.2 297

Installation of sewers 15.8 292

Snow removal 15.4 331

Table 6 : Five activities for which intentions

are constrained (in %)_________________________________________________________

Activities Percentage

_________________________________________________________

Engineering and architecture 15

Blue box system 15

Refuse collection 14

Construction of buildings 13

Collection of hazardous waste 13

Table 7 : Profile of outsourcing contracts_______________________________________________________________________________

Probability of renewing Average length of contract

the contract (in years)

_______________________________________________________________________________

Refuse collection 5.5 3.9

Processing of hazardous waste 5.5 2.8

Water supply 5.8 7.8

Sewer maintenance and repairs 5.2 2.2

Snow removal 5.0 3.2

Road maintenance and repairs 4.8 2.7

IS operations 5.5 2.3

Development is IS applications 5.4 2.3

Table 8 : Management problems with outsourcing contracts

(% of respondents)_________________________________________________________________________________

Reliability Quality of Controversy in Breach of Legal

service interpretation contract settlement

____________________________________________________________________________________________

Refuse collection 15 20 24 5 4

Processing of hazardous waste 1 2 2 1 0

Water supplies 4 5 8 2 5

Sewer maintenance and repairs 3 6 6 0 1

Snow removal 12 21 12 4 2

Road maintenance and repairs 9 10 10 2 3

IS operations 5 7 2 0 0

Development of IS applications 6 9 2 0 0

Table 9 : Management mechanisms____________________________________________________________________________________Contract Refuse Processing of Water Sewer Snow Highway IS operations Computer

management collection hazardous supplies maint. & clearance maint. & application

measure waste repairs repairs development

____________________________________________________________________________________

Meetings between 49 22 28 12 21 14 29 31

senior management

and outsourcer

Meetings between 41 25 23 24 41 27 29 28

middle management

and outsourcer

Meetings between 18 6 15 9 25 18 18 17

municipal employees

and outsourcer

Regular employee 30 8 10 9 17 9 10 13

exchanges

Use of municipal 3 4 3 3 2 1 6 7

equipment by

contractor

Transfers of employees 1 0 4 2 0 1 1 1

Arbitration mechanisms 27 10 13 7 8 7 3 4

for disagreements

Table 10 : Main advantages and disadvantages of outsourcing___________________________________________________________________________________

Advantages Disadvantages

___________________________________________________________________________________

1. Savings 1. Difficult to select best supplier

2. Access to specific expertise 2. Loss of control over the activity contracted out

3. Alleviation of constraints arising from 3. Negative impact on labour relations

collective agreements

4. Improved ability to adapt to change 4. Irreversibility of the decision to contract out

5. Reduction of payroll 5. Difficult to monitor the contract