Competing for Good Service, Great Savings

Testimony to New York Senate Committee on Labor

My name is Geoffrey F. Segal, and I am the director of privatization and government reform policy at Reason Foundation. Reason is based in Los Angeles and is a national research and education organization that explores and promotes public policies based on rationality and freedom. Reason has been researching privatization for 35 years.

Over the past decade contracting has seen substantial and consistent growth among governments at every level. Not only are they saving money, but contracting provides access to expertise, flexibility, innovation, and speedy project delivery as well. Most importantly, contracting introduces competition into otherwise monopolistic service delivery.

Why Compete?

This example from the Office of Management and Budget illustrates the benefits of competition. For years the Office of Management and Budget (OMB) has been critical of the Government Printing Office (GPO) for high costs and lousy service. Last year OMB decided competition was the only way to wake the GPO up, so they offered the job of printing the fiscal 2004 budget to competitive bidding. After much complaint and righteous grandstanding, the GPO turned in a bid that was almost 24 percent lower than its price from the previous year. That was $100,000 a year that GPO could have saved taxpayers any time it chose, but it never chose to do so until it was forced to compete.

Governments operate free from competitive forces and without a bottom line. Thus, program structures and approaches often stagnate, and success is not always visible, and is hard to replicate. Worse, since budgets are not linked to performance in a positive way, too often poor performers get rewarded as budget increases follow failure. Applying competition forces management to identify the true cost of doing business, and, with efficiency as a goal, compels an agency to use performance measurement to track and compare quality and value. At its root competition promotes innovation, efficiency, and greater effectiveness. Competition done right drives down costs and ratchets up performance.

What to Compete

There are many ways to identify where competition and contracting out might be usefully applied. The simplest is to look at where it has succeeded before. But governments would achieve more sustainable results by combining an analysis of where privatization has been successful with another tool-an inventory of commercial activities.

Applying this thinking, in 1998, Congress passed the Federal Activities Inventory Reform (FAIR) Act. Its purpose was to identify which activities within the federal government were inherently governmental, i.e., it is a job only government can do or it is commercial in nature. A “commercial activity” is a service or good that can normally be obtained from private enterprise. In the federal law, agencies perform inventories annually and identify both commercial and inherently governmental positions. With this information agencies can identify services that can be competed or privatized. The FAIR Act requires each federal agency to submit a list of activities to the Office of Management and Budget. That list breaks down the federal workforce into two broad categories: inherently governmental i.e., jobs that only government does or should do and commercial i.e., jobs that could be provided by the private sector. These are jobs the federal government can buy rather than produce-including maintenance, accounting, and writing software.

To date, only one state has a similar process-Virginia. Under the direction of the Commonwealth Competition Council (CCC), a survey of state agencies was conducted in 1999. Unfortunately, the CCC has not conducted a follow-up study. However, they surveyed all state agencies and institutions to determine what commercial activities were being conducted by state personnel with the goal that agencies would use the information to “seek ways to evaluate the costs, benefits, and possible consequences of alternative strategies to determine the best way to accomplish their respective goals, objectives, and mission.”

Even though the survey was only completed one time, the numbers are staggering. The CCC identified 205 commercial activities that were being performed by nearly 38,000 state employees! If states and municipalities adopted a similar mechanism, competition opportunities would be more transparent. Additionally, agencies would be equipped with necessary information to focus on their core functions of inherently governmental services while partnering with the private sector for commercial activities. At the local level, both the city and county of San Diego have also implemented similar procedures.

Equipped with this information, agencies can determine which activities are linked directly to agency mission or goals and which are second-tier or support functions. Applying competition to non-core activities frees up valuable resources for the agency to complete its mission and provide the greatest value to taxpayers.

How to Implement

Performance-based contracts have emerged as an important tool, providing government managers with better control over contractors and greater assurances of accountability. Unfortunately, typical contracts emphasize inputs: procedures, processes, the wages to be paid, amount or type of equipment, or time and labor used. But forcing contractors to emulate in-house procedures eliminates many of the reasons to privatize. Such micromanaging limits opportunities for the contractor to innovate, be flexible, or offer enhanced or different types of service. More and more, governments are using performance-based contracts-an outcome- and results-based approach to contracting.

A performance contract is one that focuses on the outputs, quality and outcomes of service provision and may tie at least a portion of a contractor’s payment as well as any contract extension or renewal to their achievement.

Performance contracts clearly spell out what is expected of the contractor, but the manner in which the work is to be performed is left to the contractor’s discretion. Performance-based contracts promote the broad range of privatization goals that go beyond simple cost savings. They allow governments to purchase results, not just process, rewarding the private firm only if specified quality and performance goals are met. With performance-based contracting, governments are purchasing something fundamentally different from in-house services.

Performance-based contracting addresses the problems and challenges that cause opposition to privatization. It requires agencies to set clear performance goals for privatization contracts and holds them accountable through their budgets for meeting them.

Using performance-based contracts can be challenging, as is any management change based on performance and accountability. Officials must choose services suitable to performance-based contracts and devise ways to tie payment to performance and performance to the results the public expects of the agency. Performance contracting is not a magic wand-it can be done well or poorly, and hence come out well or poorly. The key to using performance-based contracting to serve the public good is the practical, not political, matter of understanding what has worked and what has not-doing the homework.

Along with performance contracting comes a greater need to monitor contractor performance. As more agencies rely on private companies to deliver public services, monitoring and assessing these outside partnerships become vital to achieving the government’s goals. While monitoring and measurement systems are becoming more refined, state agencies need to continuously improve purchasing and oversight of service delivery. Effective monitoring pays for itself by improving the quality, transparency, and accountability of services.

Competition Trends

According to the Government Contracting Institute, the value of federal, state, and local government contracts to private firms is up 65 percent since 1996, and reached a total of over $400 billion in 2001. The Government Performance Project at Syracuse University reported that at the end of 2000 contracting consumed on average about 19 percent of state operating budgets.

A 1998 survey by the Council of State Governments (CSG) found that 60 percent of state agencies had expanded their use of privatization in the past five years, and 55 percent expect to expand their use of privatization further in the following five years. CSG asked state agencies about past and future privatization and the use of privatization. Though not all state agencies responded, the extent of privatization and the anticipation of further privatization in the future show that it is a policy tool that is here to stay. That is so because when implemented well, privatization works.

Anecdotal evidence suggests that contracting continues to grow fastest at the local level. Difficulties in reporting make it nearly impossible to present overall percentages or dollar values of contracting in municipalities. However, there are some service areas for which good data exist. For example, water and wastewater systems owned by local governments, where outsourcing of services rose by 13 percent in 2001. Additionally, a survey of the 200 largest cities found that, although fire departments continue to dominate as first responders, cities are growing slightly friendlier to private providers for medical transportation. In 2001, 37 percent of the cities surveyed turned to private for-profit agencies, up 2.5 percent from the previous year. The percentage of private not-for-profit providers held steady at 5 percent.

Some of the best data on the benefits of competition in government come from the federal government. From 1995 through 2000, the Department of Defense completed over 550 competitions, which resulted in an average savings of 34 percent-this is regardless of who wins the competition. The competitions resulted in estimated annual savings of $1.46 billion (FY 1996 dollars).

Largely speaking, there isn’t a service that is provided by government that hasn’t been subjected to competition or contracted out in some fashion. Cataloging each of these services and the results could be a hearing unto itself. With that said, however, the federal government assumes savings on average of 30 percent when competition is applied.