Disincentives

This is the fourth in a series of posts on the challenges of modern commissioning stimulated by a recent report from the Reform think tank called “Markets for good: the Next Generation of public service reform”.

The Reform report argues that public markets are inefficient because they are typically priced wrong in a number of different ways including:

  • Paying for process not outcomes
  • Setting the price too high or too low
  • Contracts being too often awarded on the cheapest price

This post examines these three issues in turn.

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Paying for process

The central rationale underpinning the payment by results approach to commissioning is that paying for the right outcomes drives the right behaviour. However, most public contracts continue to pay for inputs or outputs with the result that most providers aren’t rewarded according to how good their services are, but whether they enact certain processes.

For example, the purpose of the skill system is to equip people with the skills they need to secure stable, well-paid work. However, providers are not paid by whether the qualifications they deliver lead to work but merely on how many qualifications they deliver. So providers are incentivised to enrol learners on courses that are popular and easy and which have high completion rates. It’s this approach that resulted in the government funding 94,000 people to qualify in hair and beauty in 2010/11 – even though there were only 18,000 vacancies. In the same year, the skills system produced 40,000 tradespeople (plumbers and electricians etc.) even though there were 72,000 recorded vacancies.

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The price is wrong

Reform argues that there is a bell curve to innovation. When prices are set too high, providers make easy profits and public money is wasted. But setting prices aggressively low means that new providers are unable to innovate and tend to focus on easy to achieve results, which might not even have required a government funded intervention in the first place.

For instance, it is generally accepted that the low level of funding for the Work Programme means that providers have cherry picked those jobseekers with the best chance of finding work and ignored those with more substantial barriers to employment – even though the whole reason behind the creation of the Work Programme was to get the “hard to help” into jobs.

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Race to the bottom

Perhaps the most pernicious problem is the temptation for commissioners to award contracts primarily on the basis of price. It is, of course, unsurprising that this tendency has grown even stronger recently since all public sector commissioning takes place in the context of reduced budgets.

The procurement documentation may well insist on a high quality service which potential providers will inevitably promise to deliver in their tenders. But once commissioners set a target fee for the service and allow providers to offer discounts on this “recommended retail price”, most large providers are convinced that the best way to get the contract is to offer the lowest price.

This approach distorts the market and means that contracts are not necessarily awarded to the best providers. We have seen two recurring difficulties from this approach to procurement:

  1. Providers who are over-reliant on a single large contracts in one particular market often feel impelled to offer very large discounts. This results in a phenomenon called the “Winner’s curse” where the successful provider cannot meet the contract requirements because it does not have the funds to do so.
  2. Very large multinational companies are able to distort the market since they can afford to make loss leading bids to enter into a new area of public provision.

As we saw in last week’s post, public markets do not work in the same way as ordinary markets. In the automobile market, for example, a manufacturer who did not invest sufficiently in  a new model and produced an inferior car would soon gain a poor reputation and lose sales. However, in most public markets winning providers are guaranteed to have a virtual monopoly over service provision for the length of the contract – 10 years in the case of the recent Transforming Rehabilitation probation tendering  – while losing providers cannot even hope to enter the market again until the contract is re-tendered.

Too often governments forget the old cliche:

“Price is what you pay, value is what you get.” 

 

 

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