Has government become too aggressive with outsourcers?

Serco logo

Possibly the most shocking disclosure in the National Audit Office's two reviews of how private sector companies deliver public services is how little financial information the NAO can actually demand to scrutinise.

In order to assess the important question of whether the big contractors, Serco, G4S, Atos and Capita, are making excessive profits from their £4bn of annual business with the public sector, the government's spending watchdog had to rely to a great extent on information volunteered to them by the four.

Which seems something of a lacuna, given that a huge and rising proportion of our public services are delivered by the private sector. According to the NAO, contracting out, to the likes of Serco, G4S, Atos and Capita, accounts for "around half of the £187bn that the public sector spends on goods and services each year".

Or to put it another way, contracting out represents around 15% of all public spending and 5% of UK GDP. Private sector delivery of public services is therefore hugely important to the effectiveness of the functioning of the state and to the productivity of the economy.

Yet it is only written in to some contracts that they are "open book", that the client (that's you by the way, the taxpayer) has a formal right to know how much money the private company is actually making from a particular contract.

So what did the NAO actually learn about the profitability of the big four outsourcing companies from the information they supplied?

Well the big four say that in 2012 their respective operating margins - the profits they typically make as a percentage of sales - on government contracts were lower than the operating margin they earn on average on all contracts.

So on that basis, if the numbers are reliable, it would be hard to argue that the government is being ripped off.

But there are three qualifications to make:

1. They are all making an operating margin on government work in the ballpark of 5%, with Capita and Serco apparently generating a smidge more than Atos and G4S. But is there anything magical and appropriate about that 5% number?

Now the NAO points out that the net margin for these companies for all their work - for public-sector and private-sector work - is a bit less than the average for FTSE 100 companies.

But that may not be a useful comparison. Given the long term nature of the public-sector contracts, and that once they are won they are frequently rolled over and extended, would it be reasonable for the profit margin to be even less?

The NAO doesn't seem to have a view on this.

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The watchdog takes seriously the private sector providers when they say they may choose not to bid for future contracts in certain public services.”

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2. There is enormous variation in the profitability of different contracts, which calls into question whether the 5% average return is meaningful.

The gross profit margin (the profit before allocating overheads) for Atos on contracts varies between 3% and 22%, the range is 6-18% for Capita, it's 0-32% for G4S, and 4-13% for Serco.

Again an important question is begged, namely why there is such variation in the profitability of contracts both for individual companies and between companies?

Does this variation reflect the different degrees of risk for the contractor in each contract - which would be a reassuring explanation?

Or does it imply that there is great variation in the competence of public sector negotiators - which would warm the cockles rather less?

Again there is no definitive answer from the NAO.

3. The NAO notes that from 1 January 2006 to 30 September 2013, the value of these businesses on the stock market has risen much more than the value of FTSE 100 companies in general. In that period, the FTSE 100 index increased 26%, whereas Capita's share price rose 141% and G4S's 94%.

That would suggest investors aren't remotely worried that the profitability of government contracts is too slim.

g4s logo

Quite the reverse. It implies that the reliability of the revenues from these contracts is what matters, and that therefore the profit margins are quite satisfactory.

But, and this is quite important, the story of the relationship between the private-sector providers and the government is - ahem - evolving.

Since the 2010 general election, the Cabinet Office has aggressively tried to exercise greater central control over the awarding of outsourcing contracts.

In the process, it has obtain substantial refunds on older deals and seems to be securing better value for money on new transactions.

More recently the Ministry of Justice has duffed up Serco and G4S, by calling in the Serious Fraud Office to investigate alleged overcharging for electronic tagging of criminals.

Or to put it another way, the perceived balance between risk and reward on these outsourced deals is changing, to the detriment of the private sector businesses.

There have been big management changes at Serco and G4S, and their share prices have both fallen by around a sixth since May.

So probably the most interesting conclusion by the NAO is the one that goes against the grain of typical political and public discourse about private sector providers.

The NAO warns the Cabinet Office that there is a limit to the financial squeeze it can put on the likes of the big four, and that it may not be too long before there will be a loss of "innovation and investment" which "could pose a risk to value for money in the longer term".

The watchdog takes seriously the private sector providers when they say they may choose not to bid for future contracts in certain public services.

And that could be a problem, because - with so much outsourced since the 1980s - it is not obvious that the public sector retains the competence and skills to take back some of these services.

Or to return to where I started, given that public and private sectors are now so intimately and intricately combined, it may not be unreasonable for the taxpayer as employer to have much clearer sight of how much profit the contractor is earning.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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This column may be a bit quiet for a bit, because I am away from the office.

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  • rate this

    Comment number 354.

    Why can't the government 'procure' these companies and use after tax profits to fund the NHS?

    Taken one step further, why cant the NHS acquire or create it's own drug company and sell drugs to the rest of world to fund itself?

    NHS England spent nearly £10bn on drugs in 2011.


    How about the NHS manufacturing its own surgical instruments & other consumables?

  • rate this

    Comment number 353.

    I wonder what the Tories said they'd do about this before the election?

    Looks like we'll just have to wonder:


  • rate this

    Comment number 352.

    More apologist nonsense from Mr Peston ignoring the disaster outsourcing has been for the taxpayer,

    "it is not obvious that the public sector retains the competence and skills to take back some of these services" Oh really? so the army who had to come and cover the G4S mess of the Olympics have now forgotten how to be organised? nurses who have been outsourced have forgotten how to be nurses?

  • Comment number 351.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 350.

    "make employment & reasonable remuneration
    statutory responsibility of
    company directors?"

    Better: agree stable equal 'state income' for all (cradle to grave, penalties for lazy or criminal), companies then bid for worker-services (more for David Beckham, little for a trainee, paid to take 'special needs')

    Result: full employment, zero corruption, output maximal & optimal & enjoyed

  • rate this

    Comment number 349.


    Which raises the question, just what factors are considered when assessing costs? If a contractor says they can do a job more cheaply, and then send the work abroad, should not the resulting costs of job losses and benefits be included in calculating whether outsourcing govt. work will save money?

  • rate this

    Comment number 348.

    Perhaps we should legislate to make employment and reasonable remuneration a statutory responsibility of company directors, and link this to their pay?

  • rate this

    Comment number 347.

    Aside from profits - G4S is being investigated by the serious fraud office... and has just had it's contract renewed. Should a review not have taken place before the contract renewal. With maybe an investigation by the serious fraud office having had some bearing on the situation?

    It seems that once these companies are entrenched, it's almost impossible to remove them

  • rate this

    Comment number 346.

    One of the most disturbing things is the tendency to ignore small local companies and pay huge amounts to large consultancies. These consultancies then send the work out to India, China, Brazil etc etc
    Thus we pay MORE and employ NO British people. All because the 'big boys' can claim to have delivered similar and have financial security. The people doing the work have not delivered similar but..

  • rate this

    Comment number 345.

    "relevant metric"

    Not just 'profit margins' (exorbitant, safe, fragile)

    Nor public cost advantage, 'other things equal' (suspiciously large, comfortingly small, ideologically 'worth it')

    KEY 'metric', present or not, freedom of conscience: are ALL involved secure as equal partners in society, rationally to be trusted, NOT trying to cheat or put personal advantage above public interest?

  • rate this

    Comment number 344.

    Profit margin is not the relevant metric. You should look at how much investment the outsource company has to make and how many jobs it creates - the relevant metrics are return on capital employed and profit per employee. These are what the NAO should compare against private businesses.

  • rate this

    Comment number 343.

    How many more scandals do we need before the blinkers fall from our eyes, Atos certifying severely disabled for work, G4S charging for non services such as tagged people who are either in jail or don't exist.
    The Olympic security farce, CAPITA's failures in multiple areas.
    Private companies are costing us dearly for poor or non existent work but someones friends are raking it in !

  • rate this

    Comment number 342.

    Further from 341
    These "Teflon Suits" for our M.Ps come at a very high cost to all of us

    With all this outsourcing, has the Government anounced how much will be saved in cival service job losses ?
    Didnt think so !

    If we want to look at the efect of outsourcing, lets look at care in the comunity, "outsource the responsibilites" to local authorities, From the NHS.. Shambles, Who is responsible?

  • rate this

    Comment number 341.

    It´s all about lack of responsibility. When there is a problem, and the Pudding hits the fan, all the inept politicians can hide behind the contractor.
    The Politicians created the UK energy market, from nationalised industries. We now have 8% price increasesthis year, and forcast above inflation rises for the the next 17 years.

    There is not one politician taking any of the responsibility.

  • rate this

    Comment number 340.

    what competition ? when govt hands out lucrative contracts who are the exec directors with snouts in the trough ? How many company's out there can do the same as G4S for example - yes they go on about competition, value - really its about power without responsibility pass the buck govt - there should be good well paid jobs in civil service employment opportunities for our children

  • rate this

    Comment number 339.

    Would it be cheaper and more efficient to outsourse all the M.Ps in Westminster.

  • rate this

    Comment number 338.

    Competition is a factor in many tender exercises. The comparison between contractor prices and profits between government and private jobs is irrelevant. The comparison the tax payer should be interested in is the cost between a contractor and doing it in house using employees. So the agency rate compared against daily cost charged bythe contractor. And many I know don't compare well.

  • Comment number 337.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 336.

    Can't see the reason for commercial confidentiality for the vast majority of public service contracts. If all contracts were open to public scrutiny I can't see how that disadvantages anyone.

    Openness and transparency can only be an advantage to the taxpayer, the customer who is actually paying the bill.

    If they've nothing to hide etc...

  • rate this

    Comment number 335.

    "simple proof"
    Beguiling prospect!
    Was that EQUAL 'absolute economic freedom' dictating loss of EQUAL 'absolute security'?

    With respect to equal transparency for work 'out-sourced' as for work 'in-house', such will obtain - can only obtain - when we have agreed our equal security of income, paradoxically then freed to compete honestly & fiercely, for position & funding, in conscience


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