I’m delighted to host a short series of posts by Richard Butler and his colleague Holger Westphely from Aylesbury Partnerships on managing risk in payment by results contracts.
The focus of this series is on managing revenue risk, raising investment and leveraging management information systems.
The aim is to introduce a few helpful methods and tools that can help in a changing contracting environment; our focus is on PbR but is equally relevant to many other developments in commissioning.
I came to the Social Investment Sector, like an increasing volume of individuals, following a previous career as an investment analyst and have spent the last 5 years working with Social Organisations delivering public services. I was first introduced to PbR, its benefits and headaches, whilst working as interim Finance Director in the first year at 3SC and in the last 5 years we have seen a raft of developments that will ensure that it can’t be ignored by any organisation working in the public sector.
Since 3SC I have set up Aylesbury Partnerships with Holger Westphely, who will also contribute to this series. Our mission at AP is to ensure that the organisations best placed to deliver impact are contracted rather than necessarily those with the strongest balance sheet.
Whilst it remains to be seen whether the financial sector will learn its own lessons in risk to avoid a repeat of its mistakes, it is worth borrowing a few of its tried and tested tools and using them to develop the social sector in an increasingly risky contracting environment.
We will cover the different perspectives on risk of commissioners, investors and delivery organisations and highlight potential opportunities for the voluntary sector to capitalise on its strengths to compete with the private sector for contracts.
Three questions to ask about PbR risk
A big push by government to embrace PbR has led to it becoming a much discussed topic for debate and an area that few organisations delivering public sector contracts can afford to ignore. I will explore some of the key issues through the following 3 questions:
- Why do organisations need to improve their understanding of PbR contract risk?
- What can organisations do to effectively manage PbR contract risk?
- What needs to happen at the sector level to ensure that SMEs, Social Enterprises and Charities are able to deal with PbR risk?
This week’s post focuses on improving understanding of contract risk.
Before getting into any detail its worth defining our perspective on risk.
Having spent the majority of my career in asset management I generally come to social investment from an investor’s perspective.
When we talk about risk, we are primarily interested in its impact on returns. The most obvious risk particular to PbR contracts is revenue uncertainty. More generally the risks we talk about will have a high likelihood (or volatility) and a medium to high impact on a risk register. They could be described as day-to-day business risks, whose management forms part of your core business processes.
Why do organisations need to improve their understanding of PbR contract risk?
Grayling’s recent announcement on probation means that PbR is at the forefront of man minds working in criminal justice.
Whilst PbR is potentially subject to explosive growth there has been limited progress in building skillsets and infrastructure that would empower smaller organisations to participate in such contracts on their own terms.
There are 3 key reasons why an organisation needs better understanding of risk.
The most obvious is that if your business is becoming more risky then you need to be able to determine whether you are likely to be toppled over.
Secondly as contracts become more risky there is greater need to share that risk and you’ll need to know what you are passing on and who is best placed to take it on.
Finally if you take on additional risk in a contract you’ll need to make sure that the revenue is commensurate with the risk.
A PbR contract places greater risk on the delivery organisations than a traditional service contract, as the expected revenue amount is uncertain.
Therefore it is crucial to understand how and whether your organisation can cope with the risk that it is assuming – that much is obvious.
However the hard part is to quantify that uncertainty and communicate it to others: vital when raising capital and convincing commissioners.
More risk = complex partnerships
The increased level of risk also forces organisations to work together, whether that is within consortia, sub-contracting relationships or financing arrangements.
That adds complexity, making it harder to fully assess the different potential outcomes.
A transparent allocation of risk between stakeholders is vital to successful and sustainable contract delivery. It should force partners to align incentives, preventing exploitation of smaller organisations. As well as improving relationships with partners and investors, any improved understanding can improve leverage in commissioner negotiations where possible.
Commissioners, investors and trustees need to manage their specific risk exposures in a PbR contract.
Including quantitative measures of risk in regular communications with them is a powerful tool to help manage those crucial relationships. It demonstrates a deep understanding of contract risk and inspires confidence that delivery is well-managed.
Finally you’ll need to be sure that the amount you are being paid is reasonable given the risk you are taking on.
As a former city analyst, I could get carried away with models for pricing risk but since the city has spectacularly proved, they don’t always work.
However common sense, and your auditor, will tell you that certain contract risks will require extra reserves and those extra reserves will have to be funded so you’ll need to make sure that this is priced into you contract.
So hopefully you’ll agree with us that the public sector commissioning world is becoming a riskier place and it makes sense to understand that risk but let’s end on a more positive note.
‘Risk’ can sound like a very dry subject but all it’s about is getting a better sense of the underlying dynamics at play in a contract and being able to communicate them, which can only improve your ability to deliver and compete.
We see an increasing plethora of data available and tools that can cheaply help you navigate and analyse it with a couple of laptops and a bit of innovation.
Hopefully in the coming blogs we can suggest a few ideas and we’re always happy to chat!
Visit us at www.aylesburypartnerships.com
Follow us on Twitter: @AylesburyRisk