Outsourcing and Joint Ventures - Legal Challenges and Opportunities for Smarter Government and Operational Efficiency

In this, the last of our seven alerts covering workstreams arising from the Operational Efficiency Programme, we concentrate on outsourcing and joint ventures.

For the purposes of this paper “outsourcing / joint ventures” covers the entering into of a commercial contract by a public sector organisation with a private sector organisation for the provision of services. This approach can sometimes involve a joint venture type approach which may or may not involve the creation of a separate entity, for example, the creation of a joint venture company in which a public sector body has a minority share and a private sector a majority share.

Why outsource and what are the basic considerations?

Many of the core principles behind the OEP agenda are consistent with the traditional objectives of any outsourcing model including the requirements to:

• facilitate introduction of new technology to deliver more services to users more efficiently;
• achieve standardisation of use of resources across business delivery units or across a number of public bodies (in the case of a shared services model);
• save money;
• achieve an improved level of service for less expenditure (i.e. get more for less);
• change “fixed” costs into “flexible” costs.

A number of considerations to achieve these key objectives need to be made at the outset of any outsourcing project. However, a commissioner of outsourced services should avoid adopting an approach which emphasises price over all other considerations. It will be a combination of best value and appropriate solutions which will ultimately form the basis of a successful scheme.

A public body considering entering into an outsourcing arrangement must, at the outset, analyse and record its aims. That will provide the standard against which the customer can monitor the achievement of those aims in the procurement process, the contract negotiations with the provider and during the operation of and exit from the contract.

It is also important for the customer to be alive to objectives of the service provider in order to understand what leverage it may have in order to achieve its objectives. Clearly the key driver will be to make a profit but a supplier looking to develop its business in the new world of “Operational Efficiency” will be equally keen to provide customer satisfaction both during the pre-contract and the operational phases.

Context and drivers

There are a number of drivers for local authorities/health bodies exploring outsourcing / joint venture models at the moment.  These include:

• the recognition that an organisation’s own services are not structured, managed or delivered inefficiently. This allows an opportunity for the private sector to make major changes to the way the services are configured leading to revenue savings for the public sector body e.g. restructuring back office services;
• the recognition that the infrastructure which supports the delivery of services is outdated/ineffective and needs capital investment which the organisation does not have the means to provide, e.g. major ICT upgrades;
• the opportunity provided for potential revenue savings to be made from the integration of the organisation’s own set of services with a wider set of services run by a private sector provider. This provides the chance of critical mass and major economies of scale which the organisation alone could never achieve e.g. revenues and benefits services being provided to dozens of councils across a region;
• a reluctance to tackle head-on major HR / industrial relations practices or problems and therefore an appetite for the organisation relinquishing its role as employer and concentrating on the commissioner of services;
• a strategic view that  public bodies should concentrate on core activities and services and should not divert time into employing and delivering services which are only ancillary to their main function (obviously most relevant for the outsourcing of back office services, business processes);
• in the health market, the encouragement and need for Foundation Trusts to income generate to raise capital that is not otherwise available from Treasury.  These can be both contractual and corporate joint ventures either for the provision of supply chain services both to FTs themselves and other trusts or frontline services being directly commissioned by PCTs;
• World Class Commissioning and the continuing move for commissioner / provider PCT split under the Transforming Community Services policy will create more sophisticated commissioning of services by PCTs which will inevitably bring commercial collaboration between service providers.

Types of outsourcing / joint venture

“Outsourcing” is becoming relevant to an increasing range of services. The traditional focus for these types of arrangements has been the “back office” type support services required across all large organisations including finance systems, ICT, HR and facilities management. “Blue collar services” have also been the subject of outsourcing contracts for many years including cleaning, catering, grounds maintenance.  An increasing trend is for public sector organisations to replicate aspects of private sector practice by outsourcing services where there is a direct  interface with the “users” of the service (e.g. call and contact centres).

The nature of the legal arrangements for outsourcings can also vary considerably and covers a wide range of contractual and commercial solutions. They can cover short term arrangements through to long term commercial contracts where there is no expectation in reality that the service will ever be brought back in-house.  For example, arrangements for staff will vary hugely from large scale TUPE transfers through to shorter term secondment arrangements or the retention of management layers of staff.

Where long term service outsourcings take place, the potential for turning this into more of a partnering arrangement is attractive to public bodies.  A number of large scale transformation projects have been procured on the basis of a private sector partner initially providing consultancy advice on where significant savings can be made by outsourcing or other delivery models across all services. The contract then moves into an implementation stage with the private sector partner dealing incrementally, service by service, with the list of areas.

The decision as to whether the public body retains a stake / interest in the organisation providing the services once outsourced is an important and topical issue. There are different views on how attractive this option is to the market and also different views on the benefits to public bodies in staying involved in this capacity.  It can complicate the contractual arrangement and cause real conflicts of interest.  Conversely it can, particularly for elected councillors in local authorities, be attractive to see that they have a long term stake both in the delivery of important services to the council but also in the employment arrangements for staff. This can be an easier model to adopt in councils where there is a political resistance to outsourcing than a straight commercial contract arrangement.

A number of national programmes for the re-modelling of primary care facilities and the secondary school estate have followed this corporate JV model. In the LIFT scheme, the public bodies involved (led by the relevant PCTs) have procured a private sector partner leading to the establishment of a LiftCo in each area with private sector control.

In the Building Schools for the Future programme, the local authority has procured the private sector partner and the LEP (a private sector controlled company with local authority and central government minority interests) delivers the schemes.

The general healthcare market has the capacity to be very complex in terms of outsourcing and joint venturing.  From a commissioner's perspective (i.e. PCTs) outsourcing is likely to be focused on back office services where these can be shared with adjoining PCTs.  There is a strong possibility that, as PCT commissioner and providers continue to split, PCT providers will amalgamate into larger primary care providers and PCT commissioners likewise will amalgamate into larger commissioner organisations.  These separate organisations will then have significant back office services which may well have sufficient critical mass to justify outsourcing. 

The provider market in health already includes very large organisations in the form of Acute NHS Trusts and there are growing primary care providers for medical, dental, ophthalmic and pharmaceutical services which are both public and private bodies.  Outsourcing in this arena will be for supply chain services probably at the moment, mainly to large acute services. These would include the provision of diagnostic, haematology, pathology and pharmaceutical services and the like.  They will usually be contractual joint ventures but some FTs (NHS trusts cannot form corporate joint ventures) are considering corporate ventures with organisations providing outsourcing services back to those trusts themselves and then using that expertise as a basis for selling those services to other providers in the market. 

Legal issues in outsourcing / joint ventures

In any outsourcing deal, the usual commercial issues in relation to the scoping of the services to be outsourced will need to be addressed. These include the procurement of a private sector partner, the contractual arrangements for the delivery of services, achieving value for money, benchmarking and service improvement mechanisms, legacy and transition issues and exit management.

Where a joint venture type solution is being developed, early and rigorous thought should be given to the model of JV which will best suit the scheme. The pros and cons of setting up a corporate JV need to be fully considered – there can be real advantages in this model but there are also consequences such as tax issues which need to be thought through.

If a corporate type JV is the agreed solution, further thought needs to be given to the optimum type of vehicle to suit the project. The leading options include companies (limited by either shares or guarantee), Limited Liability Partnerships, Industrial and Provident Societies, and Community Interest Companies.

There are a range of considerations which need to be worked through to reach this conclusion, including the identity of the parties, their vires to enter into potentially novel structures e.g. LLPs, how profit and loss will be dealt with, governance of the arrangements, termination, etc. The forthcoming updated Treasury Guidance on Public Sector Bodies forming Joint Ventures with the Private Sector will be useful as a reference point as it explores:

• what structures can a JV take
• issues for early consideration
• value for money
• ownership, control and financial reporting
• joint venture assets and resources
• funding, fees, charges and tax
• structuring the JV entity
• selection of the private sector partner
• managing public sector interests in the JV.

In any JV arrangement, including those dealing with outsourcing arrangements, it is vital that the structure arrived at fits the purpose of the scheme. Although the preferred type of model in the market will vary over time as new ideas emerge, what is clear is that there will be increased numbers of schemes involving collaboration across the public and private sectors to deliver vital public services.

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