How do companies avoid corporation tax?

For a one minute explanation about how multinational companies can avoid paying tax in the UK check out this video on the BBC's website.

Transaction costs have to be paid for

Ronald Coase, a Nobel Prize-winning economist, died last week. Way back in 1932, when he was 21, he did some research into why it was that companies did not use pricing and markets to organise themselves internally even though they relied on pricing and markets being the best way to operate an economy. (See this article for the importance of this theory for the development of the internet.) The answer, he found, is that using an “internal market” brings with it transaction costs. To have an internal market a company (or other organisation) would need to spend money and resources negotiating contracts and passing invoices between divisions and units. Much easier, then, to manage an organisation by some form of command and control regime. In the public sector we have seen various flavours of internal markets and they are still in place, notably in the NHS. I'm sure the government and others would claim that the greater efficiency of suppliers that results from competition outweigh the transaction costs and perhaps they are right. (If anyone can point me to recent research which addresses this issue I'd be very grateful.)

What's on my mind, though, is a slightly different point. In a competitive market there has to be scope for losers as well as winners. We can see that because some businesses just don't get off the ground and because even successful companies can lose their market share (Nokia, for example). How can you have room for losers in an internal market without incurring waste? In particular, when the market is for public services upon which, say, vulnerable people rely, what happens if their provider is the equivalent of Nokia--once upon a time the best provider but now falling behind the performance of others? There's nothing the recipients can do: they don’t have true customer power because they don’t pay for the service (at least they don't pay the provider directly and have the option to take their money elsewhere) and the long term contract the provider has with the public authority means there isn't an immediate threat of competition to perk up their performance. I think this is because having incurred the transaction costs of procuring the contract the public authority will be reluctant to incur additional transaction costs in ending it early unless the performance is abysmal.

I think what this points me towards is the importance of good contract management for the duration of a contract. Good contract management can represent the service users and also prevent the public authority from getting in to a position where it even has to think about terminating the contract and incurring all the costs that would involve.

I think public authorities are also coming around to this view. Certainly I find myself more often talking with my clients about contract management than I used to. I suspect this reflects the maturity of the outsourcing market in two ways. First, public authorities and providers both understand the commercial issues relating to the contracts and are able to reach workable agreements much more readily than they used to. Second, public authorities who’ve reviewed their experience of contracts over the last, say, 10 years will often recognise that they have not felt in full and proper control of their contracts and that they ought to have invested in contract management skills from the outset.

I think what this means is that if an organisation wants to use contracts, whether for an internal market or externally, it is important that they recognise that good contract management will be a significant transaction cost and they need to be willing to pay for it.

Governance is a contact sport

In my previous post I mentioned the conference I attended last week on strategic partnering in the police service. One of the afternoon's speakers was Malcolm Burch, the chief executive of Lincolnshire Police Authority. His talk was about the specifics of the governance arrangements in connection with the procurement process they have undertaken but one thing he said has, I think, a general application. He referred to governance being a "contact sport". He was talking metaphorically, of course, and I think he meant contact sports like rugby rather than boxing or martial arts. The overall aim of governance, after all, is for the organisation to win not for one side to knock out the other.

Anyway, Malcolm's point was that it's not possible for governance to be carried out in isolation from the projects and activity of an organisation. Governors (ie those charged with governance of an organisation) have to get involved, they have to have conversations with people and if there are differences of opinion they have to find ways to resolve them. It would be easier for governors to say to the executive, "get on with the project and when you've finished we'll scrutinise what you've done" but that approach is not helpful to the executive and runs the risk of the project failing. There's not much comfort for governors to observe a project has failed when they might have been able to prevent it, or at least mitigated the failure.  It is tantamount to the old joke about an auditor being a person who hides in the hills until the battle is over and then bayonets the wounded. No-one needs governors like that.