UK: No More ‘Them And Us’ - Improving Supplier Relationships In The Public Sector

Executive summary

The United Kingdom has the world's second largest market for government suppliers after the United States.1 One in every four pounds spent by government (around £175 billion) is on goods and services.2 Services provided by private and third-sector suppliers often involve more than corporate support. Many public bodies now rely on third parties to deliver core public services.

As the configuration of supply chains has changed, however, public bodies have not always adapted their own capabilities, cultures and processes to reflect their new role. Independent reports have highlighted a number of systemic problems where mismanagement of suppliers has led to high costs, late programme delivery and poor service quality.

This mismatch is gradually being addressed through programmes such as Professional Skills for Government. The introduction of significant public finance constraints after 2010 will increase the pressure to accelerate this process. To ensure public bodies are fit for purpose as their budgets contract, it is now critical that managers act swiftly to refresh their commercial and procurement capabilities, and modernise their approach to dealing with suppliers.

This report describes these capabilities at a high level, and identifies common areas where public bodies can take action to improve the way they manage suppliers. Through greater use of financial incentives, enforceable measures to penalise poor performance and increasing understanding of contractual obligations, public bodies can improve the systems that underpin their approach to supplier management. At present, research from the National Audit Office (NAO) shows that in central government, around 40 per cent of managers fail to apply financial penalties stipulated in contracts when services fall below standard.3

Public bodies could also utilise structured career paths, professional training and a formal programme of supplier relationship management to improve coordination of risk, compliance and performance agreement negotiation.

Finally, by establishing better governance mechanisms and channels of communication between suppliers and senior executives, public bodies could drive engagement in supplier management issues, and improve commercial awareness and technical capabilities among the leadership of their organisations.

Beyond these measures, this report identifies three specific areas for action:

1. Improving contracting and compliance

  • Managers could ensure contracts are designed to drive desired behaviours among suppliers and make better use of financial and non-financial performance indicators that focus on outcomes.
  • Public bodies could support good business process controls by ensuring they are applied operationally. They could also make greater use of management information and independent analysis to assess supplier performance.
  • There is an increasing requirement to understand suppliers' motivations and expectations from each agreement. By using an internal assurance function to provide independent advice and guidance on contract management, public bodies can increase understanding of intentions and obligations on both sides.

2. Improving risk management

  • Public bodies need to shift their mindset to take a more commercial approach to risk. The purpose of risk management is not to eliminate all problems at whatever cost.
  • They could also work to broaden the range of contract types that can be used for different engagements and understand, especially in the current financial climate, the potential implications of driving supplier profit margins too low.
  • By considering new approaches to risk across the life cycle of a programme, including through ongoing contract monitoring and compliance, public bodies could reduce the need for risk measures that increase costs and bring delays and disruption to business continuity.
  • It may also be important for public-sector risk professionals to manage the interplay between public- and private-sector approaches that can bring a clash of cultures, processes and attitudes to risk.

3. Strengthening contingencies

  • The onset of reduced budgets from 2010 could have significant implications across the supply chain. In today's markets, having a 'Plan B' will be critical.
  • As a minimum, public bodies must prepare for business critical supplier failure by identifying operational and strategic interdependencies and areas of reliance between parties. They must also understand the likelihood of failure through market analysis, credit rating data and, where appropriate, intelligence through informal networks such as supplier forums.
  • This work could be supported by a monitoring process that provides early warning of supplier stress, establishes agreed processes for operating in the event of supplier withdrawal, and develops an understanding of the contractual position against a number of different scenarios.

Context

The way government delivers public services in the United Kingdom (UK) has changed profoundly over the last 20 years. A dual process of splitting purchaser and provider roles and outsourcing corporate functions has created new markets for competitive tender, integrated third parties into supply chains and increased the range of organisations with which government does business.

This change has been driven by political consensus that a mixed economy of delivery provides value for money, particularly when costs and benefits are assessed over the long term. Policy initiatives such as Best Value, strategic commissioning, successive efficiency reviews and guidance from the Office of Government Commerce (OGC) have done much to introduce contestability into public services, which are now increasingly described as 'markets'.

As a result, the UK now has the world's second largest market for government suppliers after the US.4 One in every four pounds spent by government (£175 billion) is on goods and services.5 To discharge its corporate functions, central government now spends around £12 billion on contracts to supply technology, facilities management and business process outsourcing.6

For their part, the top 33 local authorities are eight times bigger in terms of spend on goods and services than any single central government department.7 Councils spend around £42 billion on external contracts (over 40 per cent of all expenditure), not including national programmes such as Building Schools for the Future.8 Taken together, central and local government bodies issue up to 600 contracts every week.9 The net public-sector energy requirement is eight times larger than the largest private-sector organisations, and is worth £4 billion alone.10 Such purchasing power has the potential to distort markets and set prices.

That is demand. The supply of goods and services to government is equally striking. As 'safe' customers with strong credit ratings, public bodies can be attractive for private suppliers, especially when economic conditions create uncertainty in other markets. Suppliers supporting government now employ around 1.2 million people and collectively produce around 6 per cent of Gross Domestic Product (GDP).11 Despite a nationalised healthcare system, spending on suppliers is largest in health (£24.2 billion), followed by social welfare (£17.9 billion), defence (£10.1 billion) and education (£7.3 billion).12

New markets are opening up. During 2009 there has also been a subtle shift in attitude towards offshoring within the public sector which could bring new opportunities, but also new dimensions of complexity and international risk for public bodies. In addition offshoring is likely to remain heavily regulated centrally, which could discourage public bodies from using the practice to reduce costs.

Overall, however, the maturity of the UK market in addition to specific policies mean that some suppliers now act as the principal agent of delivery across some public services. As such they are now part of the critical national infrastructure.

The interplay between government and suppliers varies significantly (see Figure 1). Small policy departments such the Cabinet Office or the Treasury have little interaction aside from a handful of service contracts related to their business operations. In contrast, the Department for Work and Pensions operates principally through agencies that directly deliver some services and outsource others to private- and third-sector partners. Others, such as the Department for Children, Schools and Families, manage a highly-devolved network of stakeholders and suppliers. Based on a longer tradition of commissioning and outsourcing, local authority managers are perhaps more familiar with achieving outcomes without direct managerial control than their central government colleagues.

While the role of government has changed, public bodies have found the modernisation of capabilities, cultures and processes more difficult to manage. Successive reports by the NAO, the OGC, the Audit Commission and the government's own Public Services Industry Review (published in 2008), have noted that more work is required to ensure public bodies' internal capabilities and cultures reflect their modern functions. In addition, the departmental Capability Reviews that began in 2006 confirmed that skills such as contract and relationship management are in short supply in some departments, and that commercial and procurement functions require more investment and improvement to respond to mixed markets of service provision.13

The failure to confront these challenges risks more than reputational damage. Mismanagement of suppliers in the past has led to high costs, late programme delivery and poor service quality. In some instances, suppliers alone have been responsible for failure. Yet if a sponsoring authority has no levers to manage risk, uses inadequate governance and management structures, or is unable to identify and exploit mutual interests between partners, then it arguably bears some of the responsibility for programme failure.

These challenges have existed for as long as public bodies have worked with third parties. But in the last year, the impact of the economic downturn and incoming pressure on public finances have raised the stakes. In a future operating environment where budgets and supplier profitability contract, the margin for error on both sides will become smaller, and the case for running large complex programmes without the necessary commercial capabilities will become even more indefensible.

If government continues to open up the supply side of services and outsources its corporate functions, then shortfalls in areas such as contract management and compliance, risk and contingency planning must be addressed as a matter of urgency. This report describes the key capabilities needed at a high level, and identifies three specific areas where public bodies could take action to improve the way they manage suppliers.

Transforming capability

Despite the work of initiatives such as Professional Skills for Government or the departmental Capability Reviews, many public bodies continue to face shortfall across three common areas identified by the OGC's Procurement Capability Review Model and Standards Framework.14 These are 'Systems', 'Skills' and 'Leadership'.

Systems

The systems that support the management of suppliers can involve significant costs. Around two per cent of annual contract expenditure (£240 million in 2007-08) is spent on managing service contracts in central government, with public procurement processes taking around 16 months on average.15,16 The cost of bidding for suppliers is also rising. A Confederation of British Industry survey of public procurement trends showed that 88 per cent of suppliers to government felt that bid costs on like-for-like contracts had risen over the previous five years. In addition, 84 per cent felt bid costs were having a detrimental effect on competition, particularly across Small and Medium-sized Enterprises.17

Beyond the complexity and cost of processing tenders, public bodies may also lack adequate mechanisms to manage suppliers once a contract has begun. Managers do not always use financial incentives or penalties in performance management, and sometimes fail to monitor value for money over the lifetime of a programme. Other common problems include a failure to report progress and risks at board level, and a lack of high quality on-demand management information to guide decision-making.

One starting point to coordinate responses to these challenges could be to establish a programme of 'obligation management' to identify contractual commitments for each party, and describe in plain English what each contract clause actually entails in terms of obligations. The programme could also assess the impact of each obligation on process efficiency and identify clauses that have the potential to drive counter productive supplier behaviour.

Skills

Evidence from the NAO indicates that across some public bodies, there is limited internal support for developing strong, fit-for-purpose commercial and procurement capabilities. High flyers are not attracted to commercial roles and there is often no defined path for commercial or supplier management careers. In addition, there may be a lack of structured training, which can lead to a comparatively low proportion of professionally qualified commercial managers. Those professionals that are in place may be able to negotiate higher salaries if the demand for their skills outstrips supply.

Using a senior relationship manager-led programme to bring each strand of supplier management together across the contract life cycle is critical. This programme should integrate an overall strategy with a coordinated approach to risk, compliance, performance agreement negotiation and long-term relationship management. It could utilise commercial and procurement resources in a more cost-effective way, and strengthen the profile and influence of these functions within the organisation. A central programme would also act as a centre of excellence to bring together lessons learned and best practice in contract design and management.

At present, however, some public bodies continue to engage suppliers on an ad hoc basis, using inadequately funded and unprofessional procurement capabilities that have little or no long-term strategy. A senior role to bring each strand together into an integrated programme may become essential as financial pressure around supplier relationships increases.

Leadership

The third indicator assessed by the OGC is leadership, specifically the engagement with, and priority given to, supplier management by departmental and local authority boards.

This can be approximated in each organisation by the ratio of spend managed by procurement professionals, or by the seniority of the head of procurement. Less quantifiable factors can include supplier confidence and engagement with senior executives, alignment between the governance of commercial relationships and policy objectives, and the involvement of commercial managers in early discussions on new projects. One critical factor is the extent of commercial awareness and technical capabilities at board level. Another is the time set aside to scrutinise large complex outsourcing commitments or supplier relationships.

For most of these factors, evidence from the NAO and OGC indicates that local authorities are outperforming central departments. In local authorities greater experience of outsourcing and arm's length delivery has led in many cases to the establishment of a head of profession who is influential and visible, appropriately resourced, and who has ownership of a formal programme of supplier relationship management.

By contrast, some central departments do not yet give contract management the attention it requires. There are still instances where no single individual has overall responsibility for supplier management of the portfolio of large complex programmes. By default, responsibility can pass to the accounting officer.18 The Public Sector Industry Review recommended that in each department, a director of service delivery should be appointed to be responsible for the full commissioning cycle, not just initial procurement. That individual should act as the high level point of contact for suppliers, and manage a structured training and development programme to increase commercial capability within the organisation.

The three areas identified by the OGC reflect the minimum standard that public bodies must meet to adapt to their emerging role as a purchaser of services. The need to accelerate this transition has become more urgent in light of budgetary changes likely over the next spending period.

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