One theme of the coalition’s approach to service reform is clear: there is much positive talk of payment by results. This fits neatly with a world in which the outsourcing of government activities is likely to extend beyond the back office into many aspects of frontline services.

Ministers are bothered about two aspects of this change. First, are they in danger of handing over their futures to a limited number of private sector firms, given the risks associated with ‘oligopolies’? This is – in part – why we hear a lot of noise about the importance of the third sector and mutuals. An expansion of service provider markets is, in any case, likely to attract new entrants of all types and sizes. Second, how can the commercial relationships be structured so that providers’ and service users’ incentives and interests are robustly aligned?

One answer to this latter question is payment by results – now being deployed by the Department of Work and Pensions and the Ministry of Justice, while the NHS looks on with growing interest. This isn’t new, of course; payment by results structures have been built into many public sector contracts for some time, and are common in the private sector. Typically, they may involve contractors’ prices falling over time, based on the assumption that the supplier will make efficiency savings which can and should be shared with the client.

Alternatively, supplier rewards and penalties can be attached to agreed milestones or targets.
However, we are now entering a new phase, with government focusing payments on the achievement of outcomes rather than ‘inputs’. For the DWP, this will mean jobless people who successfully enter sustained employment; for the MoJ, it’s falls in re-offending rates. The attraction is obvious, and will make a lot of sense to taxpayers – many of whom both have a jaundiced view about the efficiency of public services, and believe private sector suppliers serve their own interests before those of their customers.

Nevertheless, this approach is laced with difficulties. For a start, the desired outcomes need to be right. It is no good sending suppliers off in the wrong direction, or driving them with measures that are not the most important or which distort behaviours in a damaging way. It may be tempting – but foolish – to pick the criteria that are easiest to measure or likely to grab the best headlines.

Outcomes must also be specific; this approach will only work if there are agreed objectives and methods of assessing performance. Assessment can only be made on the basis of clear evidence, and some areas of public services are more nuanced and less open to this approach.
Then there is the problem of the ‘exogenous’ events; influences outside the control of suppliers which can help shape results. The economic climate is an obvious one; levels of migration might be another. Should suppliers’ rewards be affected by these external factors?

There is also a potential conflict with the government’s desire to open up more public contracts to small and medium-sized enterprises. Some models make fees contingent on delivering to an agreed level of performance; others only make payments on delivery. Both of these put up the costs of doing business, and – because SMEs are more susceptible to cashflow problems – can deter smaller enterprises from getting involved.

The coalition government is clearly determined to pursue public service reform, opening services up to a diversity of suppliers with what the prime minister called on Monday “an injection of openness, creativity and innovation”. Yet a move to payment by results will require great care and skill; it will be important to define the right measures, negotiate the right contracts, and establish the best systems of monitoring and evaluation. Much will depend on the level of trust and openness between suppliers and the public sector. And sometimes, either or both will need to be able to say that this isn’t the best model for the job at hand.

The Cabinet Office’s Efficiency and Reform Group is currently re-designing its approach to the use and procurement of consultancy services. Recent reports by the National Audit Office and the Public Accounts Committee have echoed the industry’s view that the government should indeed concentrate on rewarding the delivery of added value and identified outcomes.

There is a growing consensus that the traditional model of payment for time and materials can distort incentives and distract from the real task.

Not every project will, or should, be open to this approach. But wider use could help achieve a step-change improvement of the scale required. The nature of the transformation awaiting the public sector requires nothing less.