Serco - Too Much Profit? Not Enough Profit?

How many public procurement people spotted the irony* in the announcements from Serco recently?

Here was one of the biggest outsourced service providers to the public sector announcing a £1.5 billion asset write-down, another profit warning, a suspended dividend, and an appeal for £550 million cash for shareholders to keep themselves afloat.

And here’s the irony – on one hand, this is a firm that the Cabinet Office asked National Audit Office to look at in detail last year to see if they were making excess profits from government contracts. That was driven by the controversy over tagging contracts for the Ministry of Justice, where Serco and G4S were found to have over-charged the department.

On the other hand, when Serco called in Ernst and Young recently to go through their contracts with a fine tooth comb to identify exposure, they found things like this (as Reuters reported):

“In one problem contract, a £175 million pound, five-year deal to provide asylum seeker accommodation in Britain, Serco loses money on each person it processes, after its bid team, largely disbanded since, failed to take into account rising housing costs, increasing asylum numbers and the pace of deportations”.

So the bid team, basically bid too low and left the delivery team to implement a contract that could never be profitable.

That raises a fascinating question though for public procurement. How much responsibility lies with the contracting authority, the procurement team and the senior responsible owner to ensure that the winning bid is feasible and at least is potentially profitable for the supplier? Or should this even be a concern for the buyer? After all, Serco still have to deliver this accommodation contract, even if they are losing on every person they process.

I’ve seen the same issue in the private sector. A Procurement Director for a large Financial Services firm was about to move their telecoms business a few years ago to a new supplier, when he received what he described as a “stupidly low” bid from the incumbent. He knew they could not possibly make money on the contract, and indeed a few years later, the firm almost collapsed under the weight of unprofitable contracts agreed by a board level individual who left rather hurriedly. But as my friend said “I can switch the business pretty easily if they do go under”. So he took the offer.

And that’s a clue to the answer to our contracting authority conundrum. It must be a question of risk. If a supplier is losing money on a contract, they have three options. They can pull out – with possible consequences for all parties of course. They can grin and bear it, and put up with the loss. Or they can start to look for economies – either genuine efficiency savings or simply cutting corners, or even worse; over-billing or outright fraud at the extreme.

So for many government contracts, I would argue there is a significant risk to the authority of a supplier losing money – the consequences can rebound easily on the buyer. So that is yet another thing for the buyer to look out for and if necessary, challenge through the contracting process. Of course, we don’t want the suppler to make too much money (and actually, NAO found no evidence that Serco were making excess profits from government contracts), but equally we might face issues that are just as worrying if they lose a fortune on our contract.

*I mean that in a genuine “ironic” sense, not as in Alanis Morissette’s famous but somewhat tenuous descriptions of “irony”.

 

Author: Peter Smith

Date: 18th March 2015

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