Transaction costs have to be paid for

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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.

Fair Tax For All?

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Fair Tax logo

I guess financial in the public sector boils down two things: getting the money as efficiently as possible and spending it as effectively as possible. My previous post was concerned with fraud which can lead to reduced income or wasted spending. This post focuses more on the collection of income. Or rather, maximising the amount of income to be collected.

Governments have many sources of income but principally they levy and collect taxes. The last year or so, in the UK at least, has seen much more of a debate about the tax planning activities of multinational companies. Indeed, Starbucks, Google and Amazon have all been in front of the UK’s Public Accounts Committee to explain themselves. And some wealthy celebrities have been exposed for investing in tax avoidance schemes. (In the UK, tax avoidance is lawful; tax evasion, on the other hand, is unlawful. What's the difference? Tax avoidance is managing your affairs to reduce your liability for taxes; tax evasion is not paying taxes that you are liable to pay.)

I suppose there have been people campaigning against this sort of activity for years but recently it must be resonating with the public mood and the issue has risen high up the public agenda. I don’t know why that would be. My take on it is that it is a corollary of the general public’s sense of unfairness—that they are paying for the bankers’ greed that caused the recession. They’re learning that not only have bankers been very well paid for causing this mess, they don’t pay their fair share of taxes. The public are receiving less public services, they’re losing their jobs (for example, the UK public sector has lost 22,000 jobs in the first quarter of 2013).

Today has seen the launch of the Fair Tax Mark. Number 1 in their list of activities is to use the Fair Tax Mark methodology to publish credible assessments of whether large companies are acting transparently and paying fair tax in the UK.They have issued a report today on 25 of the UK’s top retailers, assessing only two to be awarded the Fair Tax Mark (see this article on Reuters). You can see the marks here.

In today's press release, Meesha Nehru said:

People are increasingly expecting companies to pay the tax that society demands of them or to at least explain why not. They’re not paying, and they’re not explaining and neither are acceptable – and that’s the message of this report

They have got the backing of Margaret Hodge, the chair of the Public Accounts Committee  for their work. She hopes the impact on a company's reputation will act as a deterrent.

Undoubtedly this sort of scoring and ranking will be criticised for its methodology, not just by the companies it ranks but by observers, too. Nevertheless, I think it makes a contribution to the overall debate. Just as there are increasing demands on government to be transparent to its public, this mark is assessing, in part, the transparency of the tax arrangements of the companies that the UK public buy from every day. For that reason I’m planning to keep an eye on its development over the next weeks and months.

If you’re interested in more about this you can check out the Fair Tax Mark website and/or follow them on Twitter (@fairtaxmark).

Will fraud increase because of austerity?

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The UK was ranked 17th in the 2012 edition of Transparency International's Corruption Perceptions Index. Having heard Professor Alan Doig at the recent CIPFA Audit Conference I wonder if we may slip down the ranking over the next few years. Prof Doig is undoubtedly an expert in fraud and corruption and has applied his knowledge around the world. His friendly, wryly-humoured delivery belied what I thought was a rather bleak message. In fairly short order he demonstrated how much of the UK's public sector anti-fraud apparatus has been, or soon will be, demolished:

  • only 25% of police forces have fraud squads
  • only one force (West Midlands) out of 43 has anyone looking at election fraud
  • the Audit Commission will be abolished.

These changes come at a time when more and more public money is being moved outside of the traditional accountability structures. So, for example, a local authority's rules apply to its schools and they would be subject, amongst other things, to visits from the internal auditors. We've already seen financial management problems at academies, such as this example in London. What arrangements will apply to free schools which seem to me to be even further outside the traditional accountability arrangements? Another example: our traditional approach to providing personal social care has been for local authorities to assess needs, commission someone to provide care and then pay the bills. Increasingly individuals are being given more control of their care. After their needs are assessed they receive a direct payment from the local authority and they arrange their care and pay for it. I can see the benefits to individuals of this approach but it introduces the potential for the misapplication of the money. Surely taxpayers and the local authority need new accountability mechanisms to cover this element of public spending?

One comment made by Prof Doig has stuck in my mind: on average only 30% of fraudsters are detected. If that is the rate when we've got a lot of anti-fraud work in place what will the detection rate be in the future?

High volume, low value frauds, he said, pose a particular problem. Fraudulent claims of social security benefits have long been an issue in the UK (the Department for Work and Pensions has worked hard to get the rate down to less than 2% but it still amounts to about £2billion a year, and consequently their accounts have been qualified every year for more than two decades).

Perhaps a strategy for public bodies is to carry out a risk assessment and focus the resources on areas where the potential payback is best. When asked about this, Prof Doig identified housing tenancies and direct payments for personal social services as areas to focus on.

It's understandable that public bodies which are under pressure to reduce their expenditure have reduced the level of resources applied to preventing and detecting frauds. But it's just like cutting training. It may be understandable but we all know that in the long run it will cost us more money. To borrow a quotation from Peter Senge, "The easy way out usually leads back in."

I started this post by pondering whether the UK will fall in the CPI. That index is a relative measure so the UK's position depends also on what other countries do. I would be interested to hear if comments about whether other countries are breaking up their anti-fraud infrastructure in the way that the UK is.

UPDATE

Since I wrote this article the National Fraud Authority has published the Annual Fraud Indicator report for 2013. They estimate fraud in the public sector amounts to £20.6billion, which is of the order of 3% of total annual public spending.

CIPFA Audit Conference 2013: Keynote: Meeting the Performance Challenges

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I enjoyed being at the CIPFA Audit Conference earlier this week. Here are my presentation slides.

My presentation was the opening one. I’d been a bit nervous about it beforehand, not about the giving of a presentation but about the content. I’m not an audit specialist so I decided to talk about performance challenges from a general, big picture point of view. What I was concerned about, then, was whether what I said would resonate with any of the sessions that followed. I stayed until mid-afternoon and I’d say that all the other sessions I saw had touch-points with what I’d said. That was a relief.
Aside from what I learned by watching other people's presentations, I also made a couple of new contacts which might result in some future projects. So, all in all, it was a good day for me.

Hear me speak at CIPFA's Audit Conference 2013

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At rather short notice I have agreed to speak at the upcoming CIPFA Audit Conference in York on 22 May. I'm not a specialist in audit but fortunately my topic is broader than that: the financial and performance challenges facing the public sector. I've some ideas about what I want to say already but the preparation of a 40 minute talk will take me probably ten times that (and I'll do it the Presentation Zen way).