Free lunches and public procurement

Here's an article (in Spanish) that caught my eye this morning. A couple of interesting tidbits:

"The Spanish cleaning companies Association and the Unions trust that the new Public Contracts Law covers labour costs and to guarantee the social rights of workers in all tenders from the various contracting authorities."

 Here's what is meant by it, in the words of the Association president:

"...to include in the award criteria various elements related to the service quality, such as the working conditions offered by the companies..."

I find this article interesting for a couple of reasons. First, it is very uncommon to see both business and unions agreeing on labour costs. Second, it is possible to explain it by looking at the incentives and how they are both aligned in this instance. Let's start with the companies.

Cleaning services are incredible price sensitive and (as it is claimed) 90% of the cost incurred with each contract is simply labour costs. Companies hate competition and honestly price is the most liquid of comparators wether we like it or not. Since those contracts tend to be awarded based on price, if the costs is essentially fixed (the minimum wage) then they are effectively competing in the narrow sliver of their margin (those 10%) and that is where it  hurts. No wonder they want to either take price out of the equation or dilute with "service quality" criteria. More about this in a second.

As for the unions, they simply want a better deal for their members and there is nothing wrong with that, so they also want prices to rise assuming they translate into higher wages (they won't) or at least better working conditions for cleaning staff.

So, both parties interests are aligned in reducing price importance in the equation. In other words, both want the contracts to get more expensive. One side wants better margins, the other either more pay or better working conditions.

About the "service quality" then. The second citation above is a direct citation. The example of service quality provided by the President of the cleaning companies association has nothing to do with service quality (well, at least not directly) but with working conditions instead. To conflate the two is disingenuous to say the least. Working conditions are a problem for companies like cleaning services companies due to attrition and costs of training/recruiting new staff.

It is not surprising for me that he did not pick up other award criteria for quality. No mention of efficiency (although price is a proxy for it), availability/turn around of staff in case of spike in cleaning needs, technology to manage the contract/communications, etc. It may well be, however, that he did mention them but the reporter chose that tidbit instead.

In any case this is a roundabout way of solving the fundamental problem: wages are probably too low. It will lead to worse outcomes than solving the fundamental problem. And even then, let's be honest and assume that solving that problem implies higher taxes. There are no free lunches in public procurement.

Carillion, Capita and the obsession with lowest price contracts

In the wake of Carillion's implosion, we are coming to see the internal workings of the UK Government in a light that might be surprising or unexpected for those looking from the afar. The most recent piece of information comes in today's Telegraph and is connected to what award criteria are used. Mostly, lowest price even in large outsourcing contracts.

The Public Contracts Regulation 67(1) establishes - correctly - the principle that contracts need to be tendered in accordance with the most economic advantageous tender. 3 years after the Regulations came into force, lowest price or price only contracts should be a thing of the past. But they are not, why?

First, as mentioned in the Telegraph's piece, there is a huge pressure on budgets and that means the pressure is passed on to the private sector via price only contracts. If a large percentage of a pool of contracting authorities operating in a market all have the same approach, then margins of economic operators are indeed squeezed. By itself that is not a problem and is part and parcel on the economic world. No company likes competition, so take with a grain of salt the tears claiming contract prices in the public sector are too low. Having said that...  

The winner's curse exists really is a thing in public procurement. If only one contractor can win and the lowest price is the award criteria, there is a huuuuuuge pressure to win the contract at any cost - and try and make the difference up during the contract. In effect, quite often the prices presented to win the contract are not sustainable, ie, will not cover costs and allow for a profit to be made. Have too many of those, a little bit of a head wind and the positive cashflow won't be enough to keep the ship from keeling over. In effect, this is roughly what happened to Carillion (and may be happening to Capita as well).

In consequence, I would argue there are a lot more tenders that are abnormally low than those that are formally checked for that condition. In other words, there are plenty of apparently normally priced tenders which are effectively abnormally low depending on the financial circumstances of the tenderer and eventually other contracts the economic operator has already won or will be winning in the contract. In a world where the majority of winning tenders are abnormally low, when looked in context they will all look, well, normal.

That is only part of the story though.

Second, a longer term problem looms: lack of capacity in the public sector to deal with tender complexity. Lowest price tenders are easier to assess/compare and the corresponding decision to justify. It is no surprise they remain very popular in the UK (and elsewhere too), making irrelevant the default MEAT rule in both the Directive 2014/24/EU and the Public Contracts Regulations 2015.

This brings me to the final point: the UK pushed for significant changes to be introduced in Directive 2014/24/EU, which then led to the creation of the competitive procedure with negotiation and the innovation partnership amid other measures that I classify as being "for the 1%" of contracting authorities.

What Carillion's demise is showing is that not even the "1% of contracting authorities" have the chops to do the 'advanced' basics well (moving from lower price to MEAT) let alone deal with all those new toys included in the Directive. For years I have clamoured that what we need is to support contracting authorities in doing the bread and butter well. That means doing the actual work of training, supporting, upskilling and rewarding those at the coal face. To date I have seen zero investment from the UK Government on this (publishing guidance doesn't count...)

But that makes for less compelling marketing case than the new toys. Plus, it costs lots of money. Up front and for uncertain or diffuse benefits (ie, improving tenders, reducing risk and avoiding the next Carillion). For now, it is important to cut those budgets a little more though.

In the meanwhile, lowest price contracts remain the rule and not the exception.