Outsourcing – a changing landscape

A recent seminar hosted by broker Arbuthnot Securities and law firm Cobbetts highlighted the key themes that are taking place in the outsourcing space

Some six months on from the CSR, the fog of uncertainty has only partly cleared from the public sector outsourcing arena. However some of the features of the new landscape were highlighted by the Arbuthnot/Cobbetts Outsourcing Seminar recently. With the public sector facing well-publicised problems in meeting difficult targets, high-level participants on different sides of the equation highlighted key themes including (1) the growing appetite for new thinking on the part of the client base, (2) the increased focus on front-line services, (3) the growth of new delivery structures, and (4) some of the implications for growth and margins.

The Seminar focused on the UK, with the key theme being ‘Outsourcing in Hard Times’. Approximately 80 delegates attended including both institutional and private equity investors, local authorities, and industry representatives. Our speakers were:

• Ruth Lea, Economic Advisor and Director of Arbuthnot Banking Group
• Nicholas Griffin, Mayoral advisor on Budgets & Performance to the Greater London Authority
• Philip Fellowes-Prynne, CEO of May Gurney
• Kay Andrews, CEO of Agilisys
• Hilary Robertson, BPO Strategy Director at Steria Group.

It is no surprise that the current outsourcing landscape is dominated by the acute budgetary constraints on local authorities facing, post-CSR, c.28 per cent reductions in central government grants 2011-2015 – and on both the pressures and the opportunities for outsourcers. As a background to this, Ruth Lea outlined the pressing need for the continuing programme of measures to diminish the significant gap in the UK public finances and outlined her view that medium term growth projections are optimistic.

This would suggest that there will be even more pressure in the long term on the public sector to deliver more for less. Against a background of acute cost-pressures, it seems inevitable that the public sector will increasingly turn to outsourcers in the coming years. Leading on from the comments of Ruth Lea and Nicholas Griffin, the other panellists highlighted current austerity conditions, especially in local government finances, which made clients especially receptive to money-saving ideas. Nicholas Griffin, speaking from a client perspective, stressed the need for outsourcing companies to provide creative thinking on how to save money at the same time as safeguarding front-line services and demonstrating thought leadership.

We were struck by how consistent the speakers were in their assessment of current market conditions. Beyond the well understood challenges of the current environment, the first key takeaway was the focus on new ideas and innovation, and here the seminar threw up numerous examples of how innovation has become, in the words of Agilisys, a core requirement. A topical example is the well-known ‘Boris bikes’ project managed by Serco.

A good example of new next generation innovation on a large scale which was discussed in the Seminar is the “Elevate East London” joint venture partnership bringing Agilisys together with the London Borough of Barking & Dagenham local authority. This is a seven year, £160 million joint venture partnership which is initially outsourcing four services back to the council: ICT, revenues and benefits, customer services and procurement/ accounts payable.

Key features include joint ownership and governance, commercial flexibility to allow for growth, shared service provision and, crucially, local commitments including regeneration and local jobs. Significant (c.£67 million) savings will be made, but this is patently not a case of ‘traditional’ outsourcing. Steria’s highly innovative NHS Shared Business Services joint venture, which provides finance and a range of other services to NHS Trusts, has raised its share to 40 per cent in a matter of five years.

NHS SBS was established in April 2005 between Steria and the Department of Health to provide accounting, payroll & HR, family health services and commercial procurement services to the NHS. Growing market share has been driven by the savings of 20-40 per cent that can be reinvested by Trusts in front-line medical care – individual NHS trusts are under no obligation to use the services of NHS SBS, so this is an impressive record.

Key figures:
• Over £13 billion debts recovered per annum for NHS organisations
• Over 4.5 million accounts payable invoices processed per annum
• Over 2.5 million payslips processed per annum
• Over £36 billion payments processed per annum

A second key theme which emerged very strongly was the decisive shift in central government thinking as central government adopts a less prescriptive approach to local government and the emphasis on central targets is reduced. The Localism Bill, passing through its final stages in Parliament at the moment, is set to award Councils increased control over their budgets to the tune of 30 per cent or more as part of its commitment to “giving greater financial autonomy to local government and community groups”.

The legislation should enable councils to spend money where public clamour for spending is greatest, with the result that “political” services, notably including roads maintenance and waste management, should receive both more scrutiny and more money, at least in the blue collar sectors. Key services involved include such “front-line” chores as street lighting, waste collection/waste management and repairing potholes.

A recent survey of public attitudes put road maintenance as the top or No. 2 priority for two-thirds of respondents (while also suggesting that public satisfaction with the state of local roads had broadly halved in the last three years). Rubbish collection and management also features as a very high priority for the public, and we would expect both these areas to be boosted.

The Seminar highlighted the importance of new delivery structures, which are intended to deliver better results for the client and a “fair” rate for the job, with several of the industry panellists at the Arbuthnot Seminar flagging successful examples of Joint Venture partnerships with the public sector. These structures are driving a move away from multi-year fixed margin deals towards structures based on sharing and transparency, with multi-year fixed margin contracts effectively becoming a thing of the past. Joint venture partnerships seem to be the way forward in public service outsourcing, when outsourcing companies and local authorities share assets and business risks. Contracts are becoming more flexible, with completely transparent pricing models. Often politically more acceptable, and although margins may be modest, returns can be high, as in the joint-venture discussed above between Steria and the Department of Health.

The Seminar also highlighted, helped by some questions from SMEs in the audience, the advantages of being a relatively larger company. A Cabinet Office memo dated 2 March 2011 sets out the government’s ambition to maximise leverage in bulk procurement of services across departments with a total value of £84 billion “Nine categories of common goods and services, including energy, office suppliers and travel, will be procured centrally by October 2011 to achieve better value for money for the Crown estate.

Negotiations and legal disputes with strategic suppliers will be channelled through the Cabinet Office to harness bulk purchasing and negotiating power.” Travel alone accounts for £3 billion of cost where there is a clear case for consolidation, with consulting and energy accounting for another £8 billion. Facilities account for a further £11 billion, commonly purchased across the public sector.

A recent report by the National Audit Office highlights the need for more collaborative procurement and mentions a number of current difficulties:
 
• A lack of sufficient professional procurement specialists within government
• Poor procurement information, which prevents evidence-based procurement decisions
• A duplication of administrative effort across the public service, with nearly 50 professional buying organisations procuring similar goods and services
• Unnecessary tendering exercises undertaken at significant cost
• Public bodies paying a wide range of prices for the same commodities even within existing collaborative arrangements.

The report advises central intervention (by the Cabinet Office) to achieve consistent procurement of goods and services across the public sector.

A quoted company presenting at the Seminar, May Gurney, seems to us to be a clear gainer from some of the key trends, notably the increased freedoms which are likely to drive councils to spend more on front-line services and making longer term thinking among clients more viable. The inefficiency of repeatedly repairing the same stretch of road was cited as a potent argument for planning a longer term maintenance programme enabling 15 per cent more work to be done for the same cost, in an example quoted by Philip Fellowes Prynne, together with savings of as much as £2 million out of an overall £8 million budget.

May Gurney also revealed innovative thinking in, for instance, creating immediate efficiencies while regenerating a local authority’s road maintenance model through the use of centralised control hubs (for Northamptonshire CC) to communicate with client, operatives and other “stakeholders” including the gas, water and electricity utilities to deliver a task within a shorter time frame, again making substantial operational savings (and cutting the council’s charge claim bill by £1 million).

Recent results from May Gurney, were ahead of expectations a couple of months earlier, and suggested that there is still scope for the business to make good progress, with 14 per cent EBITA and 13 per cent PBT/EPS growth. With the stock on a low valuation at its current 270p share price (sub-5x V/EBITDA and sub-10x PE) but set to grow EPS by over 10 per cent in the current year, (Arbuthnot forecast), we remain buyers.

Survey of Public Attitudes

More priority for investment:

Roads/highways    40%
Public transport      23%
Rubbish disposal    11%
Other                      26%
Total                       100%

Source: ComRes – April 2011

Craig Fraser (Analyst/Head of Research), Nick Spoliar (Analyst) and Andrew Kitchingman (Director, Corporate Finance) make up the Support Services Team at Arbuthnot. In December, Arbuthnot completed the successful IPO of Shaft Sinkers (now capitalised at £84m). Arbuthnot is an integrated Investment Bank acting for c.70 corporate clients and part of the quoted Arbuthnot Banking Group plc. It is authorised and regulated by the FSA