Computing Applications Technology strategy and management

The Business of the State

Considering the opportunities and challenges for commercial firms involved with government business process outsourcing.
  1. Introduction
  2. What Do Governments Outsource?
  3. Why Do Governments Outsource?
  4. Corporate Responses to Government Outsourcing
  5. Is There a Limit to Government Outsourcing?
  6. Managing Reputational Risks Is Central to the Future of Government Outsourcing
  7. References
  8. Author
The Business of the State, illustrative photo

Outsourcing is big business, demand for which is generated in no small part by governments. In recent years, public sector outsourcing has outstripped private sector outsourcing, with public sector organizations around the world spending $10.3 billion in the third quarter of 2013 on IT outsourcing and business process outsourcing, compared with $6.4 billion in the private sector. The top three spending governments are in the U.S., Britain, and Australia.2 Outsourcing creates business opportunities for commercial firms in a wide range of sectors including IT, defense, security, detention and prison service, healthcare, transport, and shared services.

But public-to-private transactions in government outsourcing are rife with reputational risks for corporations. We consider the following. What has motivated governments to outsource their operations and services? What is the logical limit to government outsourcing, that is, are there things that only governments can do? And how can commercial firms balance the opportunities and challenges of providing services that used to be delivered by the government? Specifically, what are the reputational risks for corporate providers, and how is the management of these risks central to the future of government outsourcing? Answering these questions, and understanding what is similar but also different between public sector and private sector outsourcing, is of enduring importance as many companies encounter governments as their biggest clients.

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What Do Governments Outsource?

The range of things governments used to do themselves, which they now outsource, is very extensive. The U.S., for example, awarded more than $500 billion in outsourcing contracts in the 2012–2013 fiscal year. Likely most familiar to Communications readers is the outsourcing of IT services, including data management, infrastructure management, application development, and customer support. Over the past decades, many e-government initiatives at national and local levels have been digitizing citizens’ records as taxpayers, benefits recipients, and medical patients.

Another significant area of contracting out is the financing, construction, and management of hospitals, prisons, and transportation infrastructure. The Private Finance Initiative (PFI), known as Public-Private Partnerships (PPP) in some countries, funds public infrastructure projects with private capital. In the last 15 years, the British government and local authorities signed some 600 PFI contracts with a capital value of over $100 billion, including approximately 100 hospital schemes, 100 educational projects, and 43 transportation-related projects.

Economic reasons for government outsourcing are simple to understand, as they have parallels in the private sector.

National governments and international organizations such as the United Nations have also come to outsource peace-keeping and relief efforts in conflict zones, by making use of private military and security companies.9 Personnel employed by these companies may be staffed as unarmed or armed guards, and engage in a variety of settings including demining, logistical mobile security, and the operation of armed vehicles and secure telecommunications.

Governments also outsource services to each other, giving rise to ‘G2G’ (government-to-government) trade. From German police overseeing security in the streets of Mumbai to the U.S. Federal Aviation Administration (FAA) training Chinese pilots, and the Australian-led Regional Assistance Mission to the Solomon Islands (RAMSI) taking over law enforcement on the islands, the notion of the "unbundling of the nation-state" is newsworthy, if not totally new.5

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Why Do Governments Outsource?

Government budget cuts have provided the most tangible impetus for recent waves of contracting out. However, it is wise to remember also the ideological underpinnings for various forms of government outsourcing, if we wish to predict how much demand for outsourcing might occur in the future.

Economic reasons for government outsourcing are simple to understand, as they have their parallels in the private sector. In this context, government organizations are not all that different from large corporations. Both want to save money and operate more efficiently. Governments commit to infrastructure investments by balancing the need for more efficient services with the need to rein in costs. Outsourcing provides a solution to this balancing act.

Ideological reasons for public sector outsourcing have a history going back to the Reagan-Thatcher era of the 1980s.6 Neoliberalism—a belief in markets promising choice and competition—became articulated in policies to make governments smaller (via privatization) and more efficient (via new public management).

Since the 1980s, privatization involved the government selling off big chunks of assets, for example in railways, electricity, gas, water, and telecommunications. At the same time, competitive bidding was introduced to build and manage hospitals and prisons. Thereafter, further waves of privatization have become less visible as contracting out takes the form of slicing off a small part of public services at a time.

New public management (NPM) has been applied to what remains of the government machinery after privatization and contracting out. The idea here is to make government more "business-like," by subjecting public servants to the same sort of market testing as in commercial settings. In particular, NPM advocates introducing business management techniques and competition between public agencies and commercial firms to make public service delivery more efficient.1

In the U.S., the idea of "reinventing government" by Osborne and Gaebler became popular during Bill Clinton’s 1992 presidential election.7 According to Osborne and Gaebler, we should stop arguing about too much government or too little government. Instead, we should focus on better government that promotes entrepreneurial competition among service providers, competition that empowered citizens by giving them greater choice. Noteworthy, thereafter, is the "end of ideology" on the issue, as subsequent governments of different ideological leanings, at least in the three leading nations of Australia, the U.S., and Britain, have not attempted to reverse this trend toward further contracting out.

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Corporate Responses to Government Outsourcing

Wherever there is demand, firms go to fulfill it. At least, this appears to be the logic behind the rapid growth of companies that provide services to governments. The main irony is that in key sectors, the government has relied on the competitive bidding process, but ended up creating a highly oligopolistic market structure—precisely the structure that it intended to circumvent. Moreover, major service providers operate transnationally, having developed a variety of expertise through acquisitions in areas that had been reserved for public sector agencies.

The market leader, G4S, best illustrates the challenges faced by an organization of enormous scale and scope. It employs 620,500 and manages over 6,000 contracts in 125 countries, rivaling McDonald’s in ubiquity. G4S provides services in areas ranging from security, defense, justice and police. The latter includes offender management, rehabilitation, courtroom security, and police services. In policing, the act of arresting is still carried out by police officers, but G4S staff go to the scene of the arrest, drive offenders away, and process them for fingerprints and other paperwork in the company’s own "custody suites." In defense, G4S provides logistics and technical support, and risk management consultancy on mine detection and clearance. Guarding and escorting in prisons and detention centers also bring them in direct contact with prisoners and detainees, leading to managing high-risk services in difficult conditions.

Commercial firms that have governments as major clients operate at their peril if they are not fully cognizant of the motivations for public sector outsourcing.

Large companies have a clear strategy, for example to provide "security solutions." In practice, they have expanded and adapted to local jurisdictions, by following a salami technique, slicing off a small part of public services to see how far they can go.4 Thus, high-risk contracts remain financially rewarding. And testing out in uncharted waters how much they can push the boundary of the state inch-by-inch is unlikely to set limits on how far they would go.

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Is There a Limit to Government Outsourcing?

As large corporations develop capabilities in areas formerly the exclusive preserve of governments, how should one define the essential functions of government? Addressing this question is important for the sustainability of service providing companies as much as of governments.

In this context, Francis Fukuyama’s distinction between the scope and the strength of the state is useful.3 In the post-Washington Consensus era, reducing the scope of the state by liberalizing the market and privatizing state-owned assets concentrates the minds of government to ensure it retains strength, namely the capacity to provide law and order, and other public goods. One could argue that only the state can legitimately exercise force on its citizens and other nations. However, such a minimalist state could go further, and outsource the use of force to private providers under proper supervision.

In short, as we push the boundary of what can be delegated to the private sector, government becomes less the provider of public services, and more "the supervisor of proxies who do the actual work."6 Yet, government relies on private partners to do government work. A central question is no longer what only the state can do that private sector firms cannot do. Instead, the question is: How far can we make the supervisory role of the state on private actors sustainable in variable circumstances, by making use of formal contracts and informal contractual norms?

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Managing Reputational Risks Is Central to the Future of Government Outsourcing

This column thus far argued that governments continue to be market makers in outsourcing. It also asserts that commercial firms that have governments as major clients operate at their peril if they are not fully cognizant of the motivations—economic, political, ideological—for public sector outsourcing.

Looking into the future, we should be clear-headed about the challenges for commercial firms acting on behalf of governments. The key challenges lie in managing reputational risks. First, for-profit companies are unlikely to have objectives and values that match government’s mission. In order to deliver efficiency without being seen to be driving it too far for profit-making, providers might consider adopting corporate forms other than a public limited company. Second, the general public tends to use a different set of metrics to judge corporations and governments. For some, being ‘for profit’ may lead to expectations of higher quality of service. The fact that profits are made out of taxpayers’ money raises such expectations even further.

Third, the corporate reputation of providers might be at risk in democracies where they are seen to be not subject to democratic control. Citizens as consumers are likely to demand greater transparency and accountability from service providers in their attempt to exercise such control. Although large providers like G4S have developed a visible brand, this may be necessary but not sufficient. At the same time, remaining invisible behind government departmental logos, analogous to no-brand contract manufacturers as "behind-the-scene champions," as I discussed in a previous column,8 appears not to be a viable strategy in government contracting.

Public service companies are beginning to take account of these reputational risks, and might consider refraining from pushing the frontier of the state further, even as governments are willing to slice off more and more of their services. What is at stake here is not just a matter of governments finding the next areas of savings in an attempt to balance the budget. Practicing the art of the state in the 21st century is being put to test, and private sector corporations could play a part in articulating it.

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    1. Dunleavy, P. and Hood, C. From old public administration to new public management. Public Money & Management (July–Sept. 1994), 9–16.

    2. Flinders, K. Global public sector outsourcing far outstrips private sector. ComputerWeekly.com (Nov. 25, 2013).

    3. Fukuyama, F. State-Building: Governance and World Order in the Twenty-First Century. London, Profile Books, London, 2005.

    4. G4S: The inside story. Financial Times (Nov. 14, 2013).

    5. Government-to-government trade: Unbundling the nation state. The Economist, (Feb. 8, 2014).

    6. Kettl, D.F. Sharing Power: Public Governance and Private Markets. The Brookings Institution, Washington D.C., 1993.

    7. Osborne, D. Ten ways to turn D.C. around. The Washington Post (Dec. 9, 1990).

    8. Sako, M. Driving power in global supply chains. Commun. ACM 54, 7 (July 2011), 23–25.

    9. Singer, P.W. Corporate Warriors: The Rise of the Privatized Military Industry Cornell University Press, Ithaca, NY, 2003.

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