5 November 2014
Outsourcers strive to rebuild reputations after scandals
The failure of G4S to provide trained security for the London 2012 Olympics, meant the Armed Forces were drafted in
The gleaming new Fiona Stanley hospital in Perth, Western Australia, is a state of the art facility, with 783 beds, comprehensive clinical services and extensive research capabilities.
Opened last month, the hospital will also be a trailblazer for the private sector in Australia’s largely state-run health system, because Serco, the British outsourcing company, has a $4.3bn contract to provide non-clinical services at Fiona Stanley. Serco is charged with ensuring the hospital’s smooth running, and will even have 18 robots capable of delivering 2,200 freshly cooked meals each day.
The increasing involvement of private companies in the provision of health services across the world is just one example of how outsourcing companies have over the past 30 years usurped much of the work previously done by local and central governments. The outsourcing model has enjoyed rapid expansion since Margaret Thatcher, the former British prime minister, pioneered the idea of getting the private sector to run public services in the 1980s.
Baroness Thatcher’s ideas spread across the western world, and in the UK spawned three outsourcing giants – Serco, G4S and Capita. These companies have planted flags in more countries than Britain’s former colonial empire, running everything from defence, health and transport services to prisons and work programmes for the unemployed.
But in the past two years, a series of fiascos and scandals – from G4S’s failure to provide enough security guards for the 2012 Olympic Games in London, to computer glitches in Serco’s administration of President Barack Obama’s US healthcare reforms, to Capita’s inadequate supply of interpreter services in UK courts – have brought the outsourcing model into disrepute. These episodes also raised far reaching questions about how far the private sector can be used in the provision of public services.
The biggest crisis to hit the outsourcers came last year when G4S and Serco were temporarily barred from winning new British government contracts. This followed their referral to the Serious Fraud Office, the UK’s main anti-fraud agency, for overcharging on the electronic monitoring of offenders. It emerged that G4S and Serco had been billing the British ministry of justice for tracking the movements of offenders who had moved abroad, returned to prison or even died.
“This has been an absolute earthquake and a disaster for Serco,” Rupert Soames, Serco’s chief executive, said in September, when grilled by UK parliamentarians about how the company had overcharged for the tagging of offenders. “What happened was totally unacceptable and unethical. Frankly, we are deeply ashamed of it.”
It is perhaps fitting that the task of restoring the outsourcing industry’s reputation rests with Mr Soames – grandson of wartime prime minister Winston Churchill – who was appointed Serco’s chief executive in May this year.
Of the big British outsourcers, Serco is suffering the most. It fell to a pre-tax loss of £7.3m in the first half of 2014, compared with a profit of £106m during the same period last year, partly because its largest government contract – running Australia’s immigration detention centres – plummeted in value due to a policy change that has reduced the number of people using the facilities. Serco’s costs also rose because of problems with other contracts, and it won fewer new outsourcing deals than it was hoping.
The straight-talking, well-connected Mr Soames – who wore a specially made jacket emblazoned “Serco and proud of it” to the company’s annual meeting – has warned it will take time to rebuild trust and confidence with the UK government. It agreed last year to pay £64.3m to the government for overcharging in relation to the tagging of offenders.
Mr Soames highlighted the challenges of running a large company operating in more than 30 countries when he told parliamentarians: “Perhaps I may gently say that in an organisation of 125,000 people, the one thing I guarantee is that someone somewhere is doing something very stupid or making a mistake 24/7. We cannot run a completely error-free organisation.”
In an organisation of 125,000 people, the one thing I guarantee is that someone somewhere is doing something very stupid or making a mistake 24/7
- Rupert Soames, Serco’s chief executive
He is seeking to stabilise the company through a no-holds barred review of its 700 contracts, because some have low margins or are even lossmaking. Serco has put in place a more rigorous system for monitoring its contracts, to avoid a repeat of the overcharging scandal.
Such a review has already taken place at G4S, which prompted the company to take a £136m charge against earnings last year, mainly because of its settlement with the UK government in relation to the electronic tagging affair.
G4S slumped to a pre-tax loss of £170m in 2013, but it is now showing signs of recovery. The company, which changed its chief executive last year, reported a pre-tax profit of £85m in the first six months of 2014, partly because of increased revenue from emerging markets.
Less than 10 per cent of G4S’s revenue is derived from the UK government – compared with about 25 per cent at Serco – so it has been in a better position to bounce back.
The smallest and least troubled of the three British outsourcers is Capita. Indeed, it has benefited from the scandal that engulfed G4S and Serco – this year Capita won a contract to monitor offenders with the UK government after its larger rivals lost this work.
However, Capita’s pre-tax profits fell 3 per cent to £152.3m in the six months to June 30, partly because of higher finance costs.
All three outsourcers have significant debt loads following acquisitions, and Serco and G4S have both moved to strengthen their balance sheets by raising capital from shareholders.
Even if the outsourcers are correcting their past mistakes, there is a realisation among some investors that government contracts are not the safe bet they had imagined.
Industry insiders say the tendering process, particularly for public sector contracts, encourages buyers to choose the cheapest offer, rather than focusing on quality of service.
At the G4S-run Oakwood prison, near Wolverhampton, – nicknamed “Jokewood” after a series of riots – the company is paid £13,200 per inmate per year. This amounts to half the cost per inmate at publicly-run prisons.
Furthermore, outsourcers are sometimes dealing with badly drawn contracts, which are subject to constant changes – for example, the UK government increased the number of security guards required for the 2012 Olympics only a few months before the games.
The outsourcers’ mid to high single-digit operating margins are also under pressure from new entrants, including construction companies. These builders are used to low single-digit margins in their core businesses.
Still, few doubt that the outsourcing boom will continue, not least because governments are seeking to close budget deficits in part through reduced public spending.
If politicians have enjoyed beating up the big outsourcers in public, there is an acknowledgment from some in private that governments need these companies as much as vice versa. Serco’s robots serving up meals at Fiona Stanley hospital in Perth should have a busy future.