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Billions of pounds of cost increase due to contractual change, delays introducing communication networks for our emergency services, potential strains on Army personnel – our recent reports illustrate the huge importance of getting contracts right, and what organisations need to do if they go wrong. They also reinforce the principles discussed in previous posts in […]

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Getting contracts right and responding if they go wrong

Posted on May 22, 2019 by

Photo of the game of jengeBillions of pounds of cost increase due to contractual change, delays introducing communication networks for our emergency services, potential strains on Army personnel – our recent reports illustrate the huge importance of getting contracts right, and what organisations need to do if they go wrong. They also reinforce the principles discussed in previous posts in our Contract insights series: the great value of information and the crucial need to act intelligently, get risk allocation right and take sufficient time to plan upfront for all scenarios.
 


Getting the contract right

Outcome-based payments, a prime contractor model, national or regional contracting –organisations have multiple choices around the contractual mechanism they adopt. Over the last six months, we’ve seen how the choice of contractual model affects the risks to be held and managed by public sector organisations, and the importance of getting this right.

Commercial approach proved inappropriate for the nature of services

Photo of offenders being rehabilitatedThe latest of our reports on transforming rehabilitation described how, for Probation Services, the Ministry of Justice (MoJ) designed outcome-based contracts with payment by results for reducing reoffending. It aimed to encourage community rehabilitation companies to innovate. However, this approach was not well suited as it took two years for data on reoffending to become available. In addition, changes in reoffending could not be directly attributed to contractors as the likelihood of reoffending is also influenced by other services, such as support with housing, employment and substance misuse. This approach was at odds with MoJ’s low risk appetite for failure due to the role of probation services in protecting the public and delivering court sentences. Ultimately, the lightly specified contracts hampered MoJ’s ability to hold providers to account for poorly performing services.

Contractual model increased programme delivery and cost risks

Photo of CrossrailOur recent Completing Crossrail report assessed this large, complex programme to run new rail services around London. In August 2018, Crossrail Ltd announced that the programme could not be delivered on time and in December 2018, the Department for Transport announced that cost increases had resulted in a £2.8 billion increase in funding. We found that:

Bullet pointThe programme involved 36 main contracts, which increased delivery and cost risks. Crossrail Ltd did not require individual contractors to manage interfaces with other contractors. Consequently, it took on greater risk and had to compensate contractors for delays that occurred on other contracts, on which their work depended. Crossrail Ltd had planned to manage the resultant risks of handling a large portfolio of contracts through using a contractor.

Bullet pointChanges to the design of construction and systems installation work, and changes to contractors’ delivery schedules cost around £2.5 billion between 2013 and 2018. Settlement of accumulated compensation events with contractors accounted for nearly £1 billion cost increases.

Bullet pointDuring 2015 and 2016, some key contracts were moved from a target price to a cost reimbursement basis. This meant that Crossrail Ltd removed the key incentive on contractors to minimise costs and took on the financial risk itself.

The frequent re-planning of the programme, combined with increasing interfaces between contracts, meant that contractors continued to raise compensation events, and costs continued to increase. After it had announced that it would not open the central section in December 2018, Crossrail Ltd began negotiating fixed price contracts for some of the remaining work to improve certainty about costs. However, this form of contract means that Crossrail Ltd risks losing commercial levers to ensure that contractors prioritise completion of Crossrail over other projects and opportunities.
 
 
An image of the signs indicating insufficient planning from insight 1 of our guide to commercial and contract managementIn Commercial and contract management: insights and emerging best practice (2016) we stressed the need for commercial organisations to take time up-front to develop a commercial strategy as the foundation for commercial success. We still believe that many, and perhaps most, commercial and contracting issues we see result from a failure to plan for and use the most appropriate commercial arrangements. Planning provides a basis for developing the contractual approach and identifying risks.

The Government Commercial Function outsourcing playbook (pdf) explains that complex outsourcing projects can take years of planning to get right and that the NAO has flagged insufficient time as an indicator of project failure. The good news is that there are warning indicators for not getting this right (see box).
 
 


Responding when the contract does not work

Admittedly, the NAO tends to focus on some of the riskiest and most challenging government contracts, often where things have not gone to plan. Challenges could result from an inappropriate contractual approach, external events or simply poor contract management. Some of our recent reports highlight how great the challenges can be, and the time and effort needed to respond when things go wrong.

1. Amending the performance regime and contract

Photo of army personnelOur investigation into Army Recruitment described how Capita had missed the British Army’s annual targets for recruiting soldiers every year since 2013 by an average of 30%, compared with 4% in the two years preceding the contract. This could lead to greater strain on existing personnel or reduce their ability to develop future capabilities. The Army penalised Capita for missing its recruitment targets, deducting £26 million of service credits between August 2015 and September 2018 (6% of Capita’s total contract payment), but this did not improve performance.

In April 2017, the Army agreed to lower Capita’s performance targets and reset the service credit deductions. The Army was already deducting the maximum service credits and considered there was little prospect of Capita’s performance improving without concessions. It agreed to reduce its targets for the number of recruits, from its assessment of what was required to a forecast of what Capita was most likely to achieve which represented a 20% reduction on the Army’s requirement in 2017-18. The Army also changed the basis on which it calculated service credit deductions. As part of this re-negotiation, the Army and Capita agreed to introduce changes to improve performance although, as at September 2018, they were still missing targets for recruiting new soldiers.

2. Contract renegotiation

Photo of emergency services vanWe found that on the Emergency Services Network programme, it is taking longer than expected to renegotiate the main contracts. In June 2018, the ESN programme team found that its contractual agreements with EE and Motorola were “…complex, in places inconsistent within and between them and ultimately now undeliverable”. While resetting the programme strategy and timetable, the Home Office has been renegotiating these contracts. This resolved some issues immediately, and project work continued throughout 2018. However, negotiations to agree the full set of contractual changes are behind schedule and the extent to which the Home Office’s objectives for renegotiation will be met is unclear. According to the timetable at the start of the reset, the Home Office was to sign revised contracts with Motorola and EE by December 2018. The estimate at the time of our report was May 2019. Until the scope and timescales of work are agreed and contracts are signed, the Home Office may not be able to manage suppliers effectively or hold them to account.

3. Early termination

Photo of people waiting to be interviewedOn transforming rehabilitation, the Ministry of Justice (MoJ) decided to terminate community rehabilitation contracts (CRCs) 14 months early given the risk of multiple provider failures. In June 2018, the MoJ commissioned work to understand CRCs’ financial positions and to develop options for terminating the contracts. It found that, as at March 2018, CRCs faced collective losses of £294 million over the life of the contracts compared to expected profits of £269 million when CRCs had bid; a difference of £563 million. The MoJ concluded that these losses would result in providers withdrawing services, unacceptable further deterioration in performance and, potentially, multiple providers becoming insolvent. The agreement to terminate the contracts will cost taxpayers a further £171 million, at least. When added to the costs of changing the contracts in 2017-18, our report estimated the total additional cost to be at least £467 million. The full termination costs will not be known until December 2020.
 
 
These recent reports demonstrate the continuing importance for contracting organisations to act intelligently by knowing what they want to achieve, understanding how contracts are performing and recognising how and where issues arise, so as to be able to respond appropriately.

We’ve seen how upfront planning can help address these issues through asking questions such as:

  • In what circumstances could a contract be terminated? Or extended?
  • What can be learned from the contract and how will this be captured?
  • What information and data will be needed so that we can make a judgment and ensure a subsequent supplier could take over?

An image of contract planning insight 19 from NAO guide to commercial and contract management

Since late 2016, we have continually updated our insights and emerging best practice through our guides on commercial relationships, available on our Commercial capability and contract management page, and our Contract insight series of blogs.

We will continue sharing insights from our work. We welcome your comments and invite you to contact us to discuss any of these issues in more detail. Please do sign-up to receive email alerts on future blogs to keep up-to-speed with our emerging thinking.
 
 

Emma WillsonAbout the author: Emma Willson is an Audit Manager working in the Commercial and Contracting Community of Practice. The practice generates cross-government insight on commercial and contracting matters, develops best practice approaches and ensures these are applied across the NAO. Emma currently manages Ministry of Defence reports, having previously managed work and pensions related studies. Topics of past reports include contracted-out health and disability assessments, learning lessons from welfare reform and Personal Independence Payment.

 


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3 Comments

3 responses to “Getting contracts right and responding if they go wrong”

  1. @JagPatel3 says:

    It is very well producing guidance and emerging best practice on how to manage commercial relationships with government contractors, but one cannot legislate for people in Whitehall doing stupid things.

    Consider, for a moment, the procurement of defence equipment.

    Competition is the essence of free market capitalism. When it comes to procuring military equipment for the Armed Forces, the government’s defence procurement policy is absolutely clear – new equipment is to be purchased through fair and open competition. The only exceptions being off-the-shelf purchases and single-source development contracts, the latter to be awarded on a preferential basis (to the Select Few).

    In its most recent policy statement on defence procurement expressed in the Defence Industrial Policy published in December 2017, the government says (on page 23):

    “We strive to provide our Armed Forces with the capabilities they need at the best value for money, obtaining this through open competition in the global market, wherever possible. Competitive tension is the greatest driver for innovation, productivity and earning power in any economy.”

    Yet, in the very next sentence, the government goes on to make this frank admission:

    “In 2016/17, 58% of new MoD contracts by value were placed on a non-competitive basis. This has grown from 36% in 2010/11 ……”

    So, it seems that less and less use is being made of the market-based instrument of fair and open competition – which happens to be the government’s preferred policy on defence procurement. There is a suspicion that senior executives seconded from the defence industry and embedded within MoD, who remain in the pay of their employers, may have exercised their maligned influence to interfere with implementation of policy to serve their narrow business interests. Or is this a clear-cut case of the senior civil servants subverting the will of the party of government, and policy set by Ministers? What Trump calls the “deep state” which is out to frustrate his administration. One thing is for certain – there is a reluctance on the part of some people in the pay of the State to use the instrument of competition as a tool, because it creates winners and losers – reflecting their deep-rooted socialist tendencies.

    It would also explain why the defence manufacturing industry has failed so miserably to deliver equipment to the Armed Forces which is fit for purpose, adequately sustained in-service and constitutes value for money through-life.

    One of the main reasons for this appalling performance is that MoD’s preferred version of competition currently applied is the ‘sudden death’ competition, which abruptly reduces the field of Bidders from six to one, following a one-off release of the invitation to tender. See this illustration pic.twitter.com/xk0d8phEAJ.

    However, the ‘sudden death’ competition has been rendered ineffective by defence contractors who are quoting identical bottom-line Selling Prices against the same Requirement – which amounts to price-fixing on a grand scale, with the active connivance of the Secretary of State for Defence. See this illustration pic.twitter.com/BQV4KUgdNg. This is completely at odds with protecting the MoD’s commercial interests, which is what Ministers are so fond of telling the public. Worse still, MoD’s Project Team Leader at Abbey Wood, Bristol is being denied the opportunity to choose the single Prime Contractor on the basis of price competitiveness, and therefore value for money.

    This has come about because MoD’s long-standing policy of disclosing the total budgeted expenditure figure or associated year-on-year financial funding profile in the ITT has resulted in defence contractors quoting identical bottom-line Selling Prices in their ITT responses – an entirely predictable result!

    How stupid can you get?

    Even the NAO’s Comptroller and Auditor General, Sir Amyas Morse has come around to accepting that it is not clever to reveal what the government is going to spend on a particular programme, right at the outset, because in so doing, it loses a lot of negotiating leverage with the people it might contract with.*

    Sir Amyas Morse, who has just completed 10 years as C&AG has had a ringside view of the inner workings of government and is therefore extremely well-positioned to comment on central government contracting.

    It is not for MoD to tell the Private Sector what the price of a new equipment programme should be. Instead, it is very much the business of defence contractors to tell MoD how much each new equipment programme will cost, based upon the prevailing value of goods, services, labour and finance in the free market shaped, not by the interfering hand of people in the pay of the State who always get it wrong, but by competitive market forces.
    @JagPatel3

    * See answer to Q50, oral evidence from Sir Amyas Morse before the Public Administration and Constitutional Affairs Committee, Inquiry into The Government’s Management of Major Projects, HC 1631, 6 November 2018. http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/public-administration-and-constitutional-affairs-committee/the-governments-management-of-major-projects/oral/92338.html

  2. Roy Jenkins says:

    Again and again this study will have the same problem no matter what you do or change in any public serves you need full funding for it to happen unpainted by miss apps. No matter what your change to improve the services- No matter what it is N.H.S /Schools/Trains/public health/old peoples care, the changes need funding at all time not just set up, then funding is taken away for another problem in a different serves Govt. Treasury Dept must fund the changes right all the time, not just for 6 mouth time-frame hoping the problem will go away that has been created because lack of fund in the first place by Govt party in power, so please out true full funding problem before implementing any changes.

  3. Doctor Alan Cleary says:

    Dr Alan Cleary: I’m a Director of the Accorde Public Policy Forum, but more importantly, I was Deputy Town Clerk of Leeds setting up the City of Leeds Accounts Sub Committee with Sir Albert King and Lord Marshall, and Lord Bellwin, which was the forerunner of the National Public Accounts Committee and the National Audit Office. I will ask whether the speaker agrees that UK public bodies suffer greatly from an inability to agree and impose a painful penalty for actual breach of a contract apart from any provisions imposing compensation for breach. The Germans had this in their civil code since 1900, and there’s nothing more effective in making people aware of their contract obligations and constantly looking at the contract to make sure they’re complying than a provision, which says if you’re in breach you’re going to pay something that’s going to hurt you. A relative in the United States used to calculate that, but what it would cost him to set up a factory to produce the widget, which was the subject of the contract.

    Meg Hillier MP: Okay great, Richard, thank y

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