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Procurement Perspectives: Outsourcing may be contingent on market conditions

Stephen Bauld
Procurement Perspectives: Outsourcing may be contingent on market conditions

A key concern when outsourcing is used is whether market conditions permit a municipality to secure an adequate number of bids to form a suitable range of competitive suppliers.

Generally, outsourcing arrangements lead to exclusive source of supply commitments during the contract period. Even when the contract is up for renewal, the incumbent supplier will enjoy a tremendous advantage over its competitors.

Without a competitive market in which to outsource, there is a risk costs will escalate towards the monopoly price level. Indeed, one of the standard justifications for government supply of a particular commodity is the need to control price under conditions of supply that tend naturally towards monopoly.

By outsourcing, this important public policy concern is frustrating. Even if there is no true monopoly, if there are only a few suppliers who are able to bid for the work, there is a significant risk that a non-competitive price will be obtained.

An outside source of supply for some services that the municipality might otherwise provide itself may on occasion be secured by subsidizing a private sector supplier to provide that service to qualified residents of the municipality on a subsidized basis. The qualification being determined by some form of means test.

The municipality then pays either the whole of the fee for that service for those residents who qualify for a subsidy or a portion of that cost with the balance being paid by the resident who receives the service.

Three problems are likely to be encountered in such cases. First, there is the problem in properly administering the means test to ensure the subsidy is provided only to those people that qualify.

If the service provider is fully indemnified against cost and earns a percentage for each client serviced, there is a serious risk that the service provider will fail to apply the means test properly, so as to increase its own fee.

Second, there is the need to monitor market conditions to determine whether the justification for the subsidy continues to exist. Where the subsidy is provided directly to the supplier, the wisest course is to provide for relatively frequent re-application by each supplier (e.g., annual or biannual) so that each is required to demonstrate its continuing eligibility for the subsidy that is being paid.

Third, contracts for this form of service provision will often provide for fee increases based on some arbitrary formula with little regard to the suppliers actual cost experience.

Since the fees payable during the initial service period reflect the ramp-up cost of the supplier, at the very least there should be periodic adjustments related to actual expenditure, to ensure that the inaccuracies and inefficiencies in prior years do not become built into the system.

Privatization has certain benefits.

For instance, depending on how the privatization is structured, the sell-off of a government operation to the private sector can result in increased investment in the operation concerned beyond what the government would have been capable of achieving given the political constraints to which it is subject and the other demands that exist upon government revenue.

In addition, privatization can be a critical step in reversing the perception that publicly-owned operations exist primarily for the benefit of those who work for them.

Similarly, privatization can be a critical step in reversing the perception that every owned operation delivers a vital service to which all citizens are entitled to equal access, irrespective of whether they can pay the cost-of-service delivery.

If municipal assets are sold on a non-recourse basis, future losses accrue to the purchaser rather than to the city. Often the assets associated with business can be sold for an upfront cash payment, which, depending upon the applicable accounting rules, can increase government income at the time of sale.

Stephen Bauld is a government procurement expert and can be reached at Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.

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