The Effect of Market-Type Procurement on the Public Sector

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Table of Contents

Introduction
Theory
Prerequisites to success in the quasi market
Case study: The Work Programme
Application of theory on the case study
Conclusion
References

Introduction

Quasi market procurement is a system in which governments buy public services from non-public establishments, such as not-for-profit and voluntary organisations, on behalf of users.

Governments use this approach to introduce free market principles of price and quality in the provision of public services. In the United Kingdom, the system has yielded mixed results from various industries, of which the education and health sectors have been the most prominent.

One of the key theorists within this field, LeGrand (2001: 4), states that quasi market procurement is expected to lead to greater efficiency. However, Fisher (1998: 11) adds that too much emphasis on the motives of the supplier and the buyer undermine user interests, and hence efficiency.

Cooper (2009: 339) explains that the method of procurement enhances responsiveness. However, this may not always happen when large suppliers monopolise the demand and procurement of purchasers (LeGrand, 2011: A3).

Quality can improve through innovation, but this may also be undermined by opportunistic behaviour (Propper et. al., 2008: 59). Moral hazards and adverse selection can both lead to unwanted outcomes (LeGrand & Bartlett, 1993: 6). Moreover, quasi markets boost choice by driving down costs and increasing competiveness on the basis of price (LeGrand, 2001: 22).

Maintenance of close relationships between suppliers and buyers can neutralise this effect (Grout, 2009: 5). This may enhance equity by availing alternatives to users, however creaming and parking could counteract those gains (Brighouse, 2000: 103).

The above theory will be applied to a case study of the Department of Work and Pensions’ Work Programme, which started in 2011 (Newton et. al., 2012: 33). This paper will start with a definition of key terms, an outline of key theories in the school of thought.

Thereafter, some prerequisites to effective quasi market procurement will be examined, and these findings will be applied on the case study. Finally, a conclusion on whether evidence supports quasi market procurement will be given.

Theory

Definition of quasi market procurement

Government procurement is the process by which public sector organisations purchase public services from providers. These providers may include non-profit institutions, voluntary organisations, self employed business persons and the private sector.

When markets operate within the public sector, they are a means to an end, not a replacement of the public sector. This means that the government will finance services and it can still maintain its role as provider (LeGrand, 2001: 15).

In the United Kingdom, there are three areas that drive for the involvement of the market: innovation, low cost and improvement in production. The private sector has experience and specialist knowledge in various areas of service provision; therefore, this equips it with the ability to innovate.

In contrast, bureaucratic organisations tend to maintain the status quo and are slow to change (Domberger, 1998: 66). Introducing a private sector company is likely to inject new ideas into public service provision.

Aside from innovation, public sector procurement allows the public sector to benefit from low costs. Economic theory states that competition reduces monopolistic tendencies, which drives down costs. The public sector has a tendency to overstaff and to downplay cost efficiencies.

Market players are cost driven and they also have the benefit of large economies that allow them to enjoy higher returns. The notion of creating value for money has catalysed the market-driven procurement policy of the United Kingdom (Taylor, 2001: 198).

In regards to markets possessing the ability to improve production, it is assumed that when public sectors with varying expertise collaborate with one another, quality will improve (LeGrand & Bartlett, 1993: 74). These players will introduce new techniques in production, and this could lead to better outcomes.

It should be noted that various dynamics are taken into account before the realization of these advantages, as they are dependent upon the existence of favourable conditions. The question one must ask is whether the public sector readily provides these conditions.

Quasi market procurement is a method of buying public services that relies on relationships between buyers and sellers that closely resembles, but does not represent markets. It is the interaction of the public sector and non-public providers in an economic relationship. That is, the government acts as the purchaser while providers act as suppliers.

This helps to break government bureaucracy, such that public services remain in the hands of independent contractors and service purchasers (Walch, 1995: 83). Market rules of speed of delivery, quality and price apply, whilst the competition between service providers is also relevant. However, competition may not always depend on price. The state uses purchasing agencies to distribute the budget.

The method is called quasi market because consumers are not directly involved in the economic interaction; instead, the state acts on their behalf. Agents, public providers and non-profits act as the purchasers. In this particular context, the UK government chose this procurement model because it has the ability to increase choice for consumers, the rate of effectiveness as well as responsiveness of the service providers.

It should be noted that this method differs from contracting because contracting out entails transference of a public sector function to the private sector. Therefore, the latter would be responsible for all elements of service provision, including purchase.

The UK government refrains from total outsourcing because of the need to implement altruistic goals like social justice. Thus, a pure market system of procurement would be too focused on economic rules to propagate social or developmental objectives (LeGrand, 2001: 18).

Limitations and gains made through quasi-market procurement as seen through the education and health sectors

According to some, the UK government has been one of the most radical implementers of quasi-market procurement. In certain sectors, this approach has yielded substantial gains, such as in education, whilst in others, it has offered relatively little in return.

The divergent results indicate that several dynamics may come into play when implementing this model. Moreover, evidence from public institutions indicates that the extent to which these dynamics apply to a given industry will affect its outcomes (Fisher, 1998: 121).

The government has used quasi market procurement primarily to increase efficiency (LeGrand, 2001: 24). When introducing the model in various sectors, public-sector representatives have stated that it will reduce the cost of service delivery. Their assertions stem from economic principles of profit maximisation.

Quasi market providers want to get the highest value for the services they deliver, by using minimal input and increasing their output. Theoretically, the model is expected to work by increasing the productive efficiency of public service delivery. Gibbons et. al. (2005: 29) confirmed this in English primary schools, where the pupils that lived in competitive regions performed better than those that in isolated areas.

In certain circumstances, prices may not reflect the preferences of the providers and their purchasers. This stems from the sidelining of end-user needs and the focus on provider and purchaser motives during contract negotiation (Fisher, 1998: 77).

The model also heightens the degree of responsiveness within the public sector. In such cases, the needs of the public or the end consumer will drive output, as will location in certain situations. Responsiveness may not always be realised when monopolies develop on either the purchaser or the procurement side.

If state purchasers have a monopoly because minimal competition exists among them, then reactivity to consumer needs will be low. For instance, Cooper et al. (2009: 339) believe that the NHS’ responsiveness to consumer needs increased drastically during quasi market reforms in comparison to previous performances. Patient waiting times were greatly reduced, which was an indicator of commitment to quality.

Monopoly on the part of the provider can also occur if large providers dominate smaller ones. In certain circumstances, this pattern may cause hostile relationships among providers, such that a number of them may withdraw from the market. Monopolies thus cause the removal of efficient providers and maintenance of inefficient ones.

LeGrand (2011: A3) explains that in terms of the NHS, they failed to achieve tangible results in quasi reforms because of the government’s failure to ‘let go’. It continued to assist inefficient hospitals and subsequently neutralised the incentives for market competition in the health sector.

Quality is a critical motive for the use of quasi market procurement. This parameter is quite complicated to define because it means different things to different people (LeGrand, 2001: 30). Some sectors define it in terms of the intensity and nature of services provided, while others characterise it in terms of the degree of client satisfaction.

Alternatively quality improvement may occur through high economic impact, such as the financial viability of schools. Quality may sometimes be compromised when procurement occurs through opportunistic behaviour. In such cases, suppliers take advantage of knowledge gaps to minimise their costs, and thus reduce quality.

Propper et al. (2008: 80) state that, in the health sector, the UK government failed to achieve substantial returns in certain areas because of an overemphasis on price over quality. The degree to which a profit-driven provider can focus on quality over cost is quite debatable.

Literature highlights two key threats to quality in terms of opportunism. Some providers may engage in moral hazards when they knowingly commit to the provision of certain services in the contract, but then renege on the promise by placing fewer resources (LeGrand & Bartlett, 1993: 77).

Since procurement contracts do not specify all the possible scenarios that can arise and how to respond to them, some service providers may limit the nature of services that they provide. For instance, a drug rehabilitation provider may reduce the amount of contact they make with the addicts in order to reduce costs. Theoretically, one can solve this problem by continually monitoring the service provider.

However, doing so would heighten administrative costs, which is counterproductive if cost reduction is one of the key drivers for the strategy. Moreover, such an approach would minimise providers’ willingness to cooperate in uncertain situations, further obscuring the gains of this strategy.

Alternatively, quality of public services may be compromised due to adverse selection. When a provider does not disclose all the information about their ability to offer the services, the purchaser is at a disadvantage. The public service purchasers may be better off getting the service elsewhere, but because they are unaware of the flaws, they may select an inefficient party.

Asymmetric information can be detrimental to the quality of the public service procured. One can assert that it is easy to minimise this problem by drafting an explicit contract; however, this could increase the transactional costs of the relationship. Social services are complicated and it is difficult to think of all future contingencies. This neutralises the noble intentions of the quasi market model (Bartlett et. al., 1998: 191).

The platform of quasi market procurement also leads to greater choice, in theory. If the government were to maintain a monopoly of public services, consumers would have nowhere to go for better services. However, when a series of providers exist, then it is possible for individuals to find outlets for their respective needs.

This goal may not always be realised, particularly when providers and purchasers develop a very close relationship. The provider may be reduced to nothing more than an implementer of the decentralised budget (Grout, 2009: 55). Usually, a lack of change in mindset may propagate the problem and if such conditions exist, then clients will not really get a choice. They will simply be switching between different types of implementers.

In the United Kingdom, some scholars believe that quasi market reforms led to greater choice among consumers in the health sector (Cooper et. al. 2009: 339). While switching may not have been evident in the sector, it still occurred.

Hospitals with shorter waiting times and impressive quality parameters, like low death rates, experienced a rise in consumers. This implies that the quasi market model provided health consumers in the NHS with the right to choose.

Equity is also a critical consideration in the adoption of this model. The government has stated that its concern for provision of social services to all categories of consumers has led to the proliferation of this model. It is assumed that the quasi procurement model treats the needs of the public as its primary goal, rather than other factors such as social status or income.

Perhaps one of the biggest challenges that the state must contend with in this model is risk selection (Brighouse, 2000: 42). Certain providers engage in “cream skimming” (or creaming), whereby they discriminate against expensive users (Walch et. al., 1997: 44).

For instance, education stakeholders may only target average-educated communities and sideline the uneducated ones. Creaming goes against the primary aim of providing social services as it leads to inequity.

Sometimes the condition of the industry will provide more incentives for creaming. In the health sector, Propper et al. (2008:134) were surprised to find that minimal inequity arose in the health sector among low-income consumers. One may postulate that this was because the end user did not do the procurement.

Conversely, in the education sector, the end user, as a procurer, has significantly less advantage over the service provider. Parents and pupils have no way of protecting their interests (Taylor 2001: 211).

They lack access to information and cannot travel to their preferred providers. Furthermore, a hierarchy exists between schools on the basis of academic attainment and geography. Therefore, schools engage in creaming by basing recruitment on these aspects.

Prerequisites to success in the quasi market

Market structure

For the quasi market procurement method to work, favourable structural conditions need to exist. The provider and purchaser ought to be separated during tendering. Sometimes the separation may exist on paper, but will not be realised in practice because of difficulties in changing mindsets.

Derkensen et al. (2000: 81) explain that the non-existence of competition among avoiders also leads to challenges. This is especially true when government monopoly exists in the provision of certain services. Usually, these challenges can be tackled by having well-defined tendering procedures and suitably designed contracts.

When designing contracts, duration and scope are the key traits. If a contract is too long, it may cut out other providers, and if it is too short, it may not allow providers to recover their investments. In addition, if the scope is too large, it may create a monopoly by only allowing large players to participate.

In this aspect, the level of specificity of investment needed during the service provision affects the degree of competition. If the details are too expensive, then fewer players will enter. The degree of quality description in contract may impede entry of new players if it is too rigorous or unrealistic (Walch, 1997: 60).

In the tendering process, a balance should be maintained between price and competition. If it is easy to define quality, the price should be the only criterion that governs the quality selection. However, in many circumstances quality is ambiguous; therefore, price will not be the only consideration.

Even when under-pricing, bidders may not understand the magnitude of what they are purchasing, so price competition need not be the only parameter. When using quality, purchasers may select bidders that have expertise in the service.

However, this could lock out potentially qualified providers whose past may have been irrelevant to the current public sector environment. Those in authority must therefore decide the weight that they can allocate to price and quality in order to match their users’ needs (Domberger, 1998: 23).

Sometimes the level of centralisation among the purchasers also affects outcomes. If a tendering process is clearly defined by the central government with well known procedures, then bidding will be transparent and the best candidates will be selected.

However, if it is decentralised, then purchasing organisations will incorporate the needs of their consumers in the model and this will fine tune the process. Therefore, procurers must incorporate both centralisation and decentralisation in tendering procedures (Walch, 1995: 54). They need to have a uniform procedure for tendering as this also minimises transaction costs.

Accountability

If a procurement system is based on outcomes, chances are there will be a shortage of information on what providers are required to do. This may lead to poor coordination between providers as work will be done independently.

Furthermore, transparency may also be introduced by evaluating and monitoring programmes. However, these entities will only yield positive results if they work in conjunction with other monitoring bodies, and avoid overlaps (Fisher, 1998: 22).

Supervision of contractual compliance can ensure accountability in public systems. This may be carried out to ascertain whether the outcomes that the state paid for, is being delivered or not. However, if a monitoring process is too strict, then it may minimise flexibility among providers, who may only focus on the actual monitoring process.

They may also refrain from innovating or even improving a service, because these aspects are not monitored. Extremely rigorous monitoring procedures may also take a toll on the administrative load of the purchasers (Productivity Commission, 2002: 85).

Performance measurement may also be another mechanism for instating accountability in quasi market procurement. It only works, however, if the providers understand the sign posts being measured, and purchasers refrain from changing them.

Additionally, the parameters being measured must relate to the needs of the user; otherwise, it will cause providers to dwell on the measures rather than their mandate. Furthermore, if the measures are too narrow, then they will move providers away from their core activities (Struyven et. al., 2002: 162).

Transaction costs

During the tendering process, providers and purchasers ought to understand their transaction costs. Purchasers often incur costs when specifying information about their contracts, when negotiating agreements and monitoring the contract. If senior level expertise is lacking in these areas, then those costs can go up.

A vast number of resources, including people and time, may be necessary in instating competitive tendering. On the supply side, entities will incur costs when preparing their bids and when making room for measurement of their bids (DEWR, 2002: 95).

Costs can also escalate during contract termination and renewal. This causes uncertainty among providers and confusion among users (Domberger, 1998: 72). Procurers can solve this problem by carrying out the bidding process in a two-stage process that allows for rollovers for previously well-performing providers. However, only a certain percentage should be permitted to roll over in order to stimulate competition.

Incentives

The degree to which the procurement process deals with incentives can mitigate some of the challenges of this model. Information asymmetries exist in the quasi market structure, and on certain occasions, providers have a greater understanding of the consumer base than purchasers, which can cause them to take advantage. Their skills and technologies are only known to them, so purchasers can only make an estimate.

To mitigate these imbalances, financial incentives must exist to guide provider behaviour. Purchasers can pay fees for input whenever they secure a contractor, and then offer bonuses for outputs. The balance of input and output payment can neutralise information asymmetries substantially. However, some operational costs, such as training, are difficult to define, so they may demoralise providers (LeGrand, 2000: 31).

It is essential to align incentives with long-term goals. Outcome-based payments cause providers to align their behaviour with payable measures. If outcomes are short term, providers will pick users whose needs fall within the time frame of the next outcome payment. They will also select clients whose service needs are easiest to meet. Therefore, incentives that focus on long term needs ought to be given due priority (Alcock, 2010: 18).

Tackling cream skimming

A working quasi-market procurement system is one in which mechanisms exist to eliminate creaming. As mentioned earlier, creaming occurs when procurers select easy candidates.

Additionally, parking occurs when providers offer minimal assistance to users who appear difficult. Some users may engage in self parking behaviour if they are demoralised. Procurers can mitigate this problem by requiring providers to take on all users consigned to them (Grout, 2009: 13).

The problem of creaming may also be counteracted by adjusting the payment system. Purchasers can give more weight to difficult users during payment, so that providers have an incentive to work with them. Parking may be dealt with by offering provider a fee for offering any service to the consumers. This will give them an incentive to focus on user needs and outcomes rather than cost cutting.

Overall, the challenge of creaming comes naturally to a profit-making body. Therefore, purchasers must take proactive measures to mitigate them. Properly defining the target group and placing their needs in contracts will ensure that selfish behaviour among service providers is mitigated.

Case study: The Work Programme

The Department of Work and Pensions (DWP) led Work Programme is an example of a quasi market procurement strategy. Malik (2013: 5) reports that the Public Accounts Committee gave a damning report on its success, wherein only 3.6% of the users in the programme were able to access permanent employment. This fell short of the 11.9% performance target set by the department.

Additionally, the group of people that were the hardest to assist; that is the youth, received minimal assistance. In the year 2013, only 20 out of 9,500 claimants under 25, had jobs that lasted longer than three-months (Stevenson, 2013: 8). Persons with disabilities were also another difficult group that has not enjoyed much assistance.

Thus, issues of creaming and parking became a reality in this scheme. 18 providers are responsible for the programme, yet none of them have achieved their contract goals.

In fact, their presence seems to have exacerbated the problem of unemployment because the Department had predicted a much lower number of the unemployed in the absence of the programme. Stakeholders, like members of parliament, predict that service providers will go out business when the purchasers cancel their contracts (Malik, 2013: 8).

The latter view is held by the public accounts committee and the media. Some research firms, like the Institute for Employment Studies, found that modest gains were taking place in the programme (Newton et. al., 2012: 38).

However, their objectivity may be put into question owing to the fact that they were commissioned by the DWP at the outset, which is the primary procurer of the program. Other stakeholders claim that it is too early to judge the program since it has only been in operation for two years.

Newton et al. (2012: 40) did not assess the programme quantitatively and found that certain discrepancies existed. Providers’ definition of sustainable employment differed from the public’s perception of the same.

Furthermore, providers focused on classifying users on the basis of distance and the degree of support that they require; therefore, selectivity was taking place. Most providers focused on job searching without considering other methodologies. Many providers had a problem with the sanctioning process and felt that communication was lacking.

Stevenson (2013: 11) blames these disappointing results on the ‘payment by result’ system adopted in the programme. Public accounts committee members have also quoted the latter strategy as the key culprit behind poor performance. Funding is based on a provider’s ability to meet its targets. This has reduced providers’ cash flow and their incentive to stay in the programme.

Many of them claim that the defined targets are unrealistic and too stringent. They also believe that the system lacks transparency, owing to its continued propensity to delay the release of those outcomes. Furthermore, many do not understand how the government came up with some of its respective performance measures.

In essence, if the abysmal performance continues, then subcontractors and key providers will go out of business, job seekers will lack help and the government will lose more money on new procurements.

Application of theory on the case study

As mentioned earlier, a quasi market procurement system only works when certain measures are in place. It appears as though the Department of Work and Pension did not instate these conditions.

In situations where it committed to the precondition, The Department did not follow through on implementation, or it overemphasised it at the expense of other parameters. Key areas that needed more work were performance measurement, contracting and incentives.

Some of the approaches in the scheme may explain this dismal performance. Most providers emphasised job searches over and above other means of unemployment assistance. While making job applications, preparing CVs and performing online job searches are crucial to service provision, they are not the only methods that can reduce unemployment.

Training and support are critical to dealing with long-term aspects of work, but it seems like most providers were unwilling to use this strategy. This sort of behaviour may be interpreted as a moral hazard because the providers are only selecting easy interventions in order to make them appear like they are working (Pollitt and Bouckaert, 2000: 55).

The Department of Work and Pension could have prevented the above problem by including these other forms of assistance in the contract during the procurement process. It would have also paid for training or other long-term services designed to assist the long-term unemployed.

Resource constraints are often some of the most obvious causes of parking (Kahkonen, 2005: 20). Service providers will attempt to protect themselves by focusing on visible approaches, and sadly, this is what took place in the Work Programme.

The case analysis also demonstrates instances of creaming and parking. Providers are engaging in the behaviour because they want to achieve performance targets. This suggests that the incentives in the performance scheme were not sufficient to cause a change in behaviour (Moyes et. al., 2011: 29). The government had implemented differential payment in order to avoid the programmer.

However, this approach has not yielded results because the user groups and weight accorded to them in the payment system were not equivalent. If the government increased the weight in accordance to the hard-to-help candidates substantially, then this might affect provider behaviour.

Another approach could be careful selection of providers during tendering. They need to demonstrate expertise in dealing with hard-to-place consumers as they are most in need of the service (Lowery, 1998: 139).

Problems with performance measurement are also evident in the analysis. The literature highlighted that purchasers need to have a clearly defined performance plan that all the stakeholders understand. It appears that the service providers are more inclined towards providing users with any jobs. Moreover, in the majority of cases, these jobs are temporary and involve no contracts.

Therefore, no sustainability of employment is offered in the programme. Conversely, the Department of Work and Pensions expects providers to offer long-term employment and assessment of their effectiveness (Stevenson, 2013: 11).

Thus, a mismatch exists between provider and purchaser expectations of performance. It is necessary to clarify these expectations during the contract negotiation process and also to explain to providers why certain goals have been selected. This would work to the advantage of the concerned groups.

Excessive measurement and unrealistic performance targets are another problem in the programme. First, the Department of Work and Pensions could have tackled this problem by defining performance measures in terms of what users need, rather than what the providers can offer (Battye, 2011: 15).

Furthermore, they should not have made these measures so narrow because they stifled creativity among providers. There also appears to be shifting performance signposts, which undermine provider outcomes. Perhaps most importantly, the goals are only short-term, and therefore, need to align with employees’ long term needs.

Stevenson (2013: 9) states that the Work Programme lacks transparency. Information sharing was deficient among providers and oversight authorities did not work together. This problem can be mitigated by fostering a greater degree of cooperation between stakeholders.

Information sharing should be streamlined and the concerned monitoring bodies need to work in tandem with other. Care should be taken to avoid excessive monitoring.

Conclusion

This essay demonstrates that certain prerequisites in the market need to exist for quasi market procurement to fruition successfully. These include accountability, proper market structures, low transaction costs, proper incentives and mechanisms to handle skimming.

Evidence from the education and heath sectors indicate mixed results. Some gains were made in education and heath through performance improvement and greater choice, respectively. However, problems of inequity, high transactions costs and centralisation behaviours undermined the reform.

In the case study of the Work Programme, it is clear that the lack of transparency, selectivity in service provision and failure to meet performance goals stemmed from the above mentioned prerequisites to success. Moral hazards occurred because contract negotiation did not stipulate other aspect of job searches.

Cream skimming could have been prevented by providing greater weight for the hard-to-help users, and selection of experienced contractors with this user group during tendering. Failure to clarify expectations in negotiations and poor performance measurement are to blame. If these issues were incorporated into service provision, the Work Programme may have worked.

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