How To Compare Costs Between In-House and Contracted Services


Fiscal constraints are prompting state and local officials to streamline government operations, and contracting out has emerged as a popular tool for providing high-quality services at the lowest possible cost. State and local governments in the United States currently contract for over $100 billion in services every year, and interest in contracting out is increasing.

Though there are many considerations that enter into the privatization decision, cost is unquestionably among the most important. Public officials seeking to make an informed judgement need access to accurate assessments of the costs of both in-house and contracted services. This guide presents a step-by-step approach for assessing the true cost of service provision.

Historical public-sector accounting practice is ill-suited to this task. The most common reason governments contract out is to save money, yet because government activities are typically funded through several departments, officials are often unaware of the full cost of providing a given service. One major national study suggests that the true cost of public service provision is frequently underestimated by as much as 30 percent. This guide identifies costs that are often ignored in calculating in-house costs.

Likewise, ancillary costs associated with contracted services, such as contract administration and monitoring of performance, can often be overlooked as well. This guide presents accepted financial practices for estimating the total cost of a contract, which includes monitoring and administration.

The question of which costs should be considered—fully allocated, avoidable, and marginal—in comparing service delivery options is also addressed. These accounting concepts are defined, and their appropriate use in choosing a means of service provision and estimating cost savings is discussed.