Deloitte’s team of experts has analysed the issues which affect organisations across the public sector. These themes look at the impact of the spending review on capability, the regional distribution of the costs and how the sustainable cost reduction can be achieved.

Key themes

1) Cost of cuts and spending plans
The Government’s plans include a return to Departmental Expenditure Limits not seen for a decade. Retrenchment at this scale over such a short period has never been achieved by any post-war administration.

2) Public service reform
Ministers have devised a busy programme of activity that includes public sector pensions reform, public sector compensation and pay review as well as localism and the ‘big society’ agenda.

3) Management of spending versus cuts
Government has said it wants finance leaders to play a central role in delivering the austerity agenda.

4) Productivity
Productivity will be a major challenge for government as budgets decline.

5) Public sector workforce reform
The Government expects 490,000 public sector job cuts over a four year period.

6) A mixed economy of service delivery
The Government views the entry of new providers into public services as essential to bring spending down and improve services to the end user.

7) Wider economic impact
Government spending has a significant impact on the UK’s economy.

1) Cost of Cuts / Spending Plans
•    The cost of cuts
•    Managing Liabilities
•    Impact on the labour market
•    Information Analytics

The cost of cuts 
Our view is that to reform or repurpose large complex organisations sustainably requires strategic thinking and initial investment. Deloitte has supported many private and public organisations on cost reduction and transformation programmes. In almost all cases, major change involved upfront funding.

To cuts costs simply by stopping activity is rarely sustainable. There are a number of areas where government will need to ‘spend to save’ across specific areas to ensure cost reduction leads to clear improvements in service quality.

As a simplified example, our experiences working on large cost reduction programmes in the private sector suggests that a one-off average outlay of around £1.25 is associated with removing £1 worth of unnecessary cost. (It is important to note, however, that removing £1 of cost is a recurring saving per annum.)

The cashable benefit is clear after just one year, but in the public sector where there are particular political tensions, the upfront costs may prove prohibitive. For example: setting aside Annually Managed Expenditure, aggregated Departmental Expenditure Limits for 2010-11 come to around £378bn. Once resource and capital DEL for protected Health and International Development spending are set aside, we are left with £265.9bn.

The Government has said it wants to extract 20 per cent on average from this value - £52.18bn. By applying our estimate of £1.25, we arrive at a figure of around £65.2bn of investment required to meet the target reduction figure over the review period.

This analysis gives a notional or indicative value and does not represent a prediction. However, we are already seeing its practical manifestation across cost reduction plans that have been announced. For example, within the Government’s welfare-to-work reforms that seek to cut up to 25 per cent of the Department for Work and Pensions’ administrative budget, it transpires that private suppliers may require up to 30 per cent of the contract value upfront to support their cash flows.

In addition, wider structural reforms may also need to be phased in over two Parliaments to spread the £3.6bn upfront cost of change. As we see more reforms come through, we can expect more costs of change – especially for more radical or structural changes. The latest intelligence on the cost of closing quangos is another example.

Managing Liabilities 
Attrition across public sector organisations has the potential to leave expensive liabilities for government through legacy assets or opportunity costs associated with mothballing property. Public sector leaders should also assess what happens to demand previously met by a closed organisation, and whether the whole-life cost of diverting demand and managing legacy assets do not undermine the business case for immediate administration.

Impact on the labour market 
Large scale headcount reduction has the capacity to cause widespread distortions in the job market – especially in areas which depend on the public sector for jobs, investment and economic growth. To manage an effective redundancy programme, fairness and the perception of fairness will be essential, together with a baseline preference to transfer high quality staff into other roles (such as in-demand commercial or finance functions), as well as into the private sector.

Thinking about these risks from the beginning will be critical. To ignore staff welfare or abrogate responsibility for outplacement risks legal challenges – especially from women who may be disproportionally affected by cuts: women are twice as likely as men to work in the public sector, with the highest proportions in the areas likely to be hit hardest overall: Wales (46 per cent), the North East (45 per cent) and Scotland (43 per cent).

Information Analytics 
Our view is that there is systemic weakness in the general capability of public bodies to develop business cases for programme activity. Mangers often struggle to define overarching benefits for any given programme or area of spend. There can be common failure to measure outcomes or verify their achievement. Processes to track benefits may be weak and we have seen little evidence in the public sector of post-investment reviews to inform future decision-making.

Rebecca George, Deloitte public sector partner said: “Unintended consequences have affected public sector performance in the past, but now the stakes are higher. A programme to manage the largest spending cut in modern history, and simultaneously redraw the boundaries between the state and citizens carries considerable risk. Understanding the cash cost of cuts, together with risks brought about by headcount reduction and closures are important. But ultimately, the largest risk to government is if it chooses to limit the ambition and scope of the Review to a simple cost reduction exercise. If it decides to decouple public cuts from wider structural reforms or defer them to a later date, then rapid decline in public and business support for the Review may follow.”

   

2) Public service reform

The Review has kick-started the behavioural and structural reforms necessary to achieve capability transformation, but more will become clear once departments have published their structural review plans. Uniform percentage reductions with no adjustment for strategic capability requirements puts services at risk. Staff churn also threatens public bodies’ ability to embed specialist skills to manage transformation in the longer term.

Managed incorrectly, the Review risks becoming another ineffective machinery change. There have been 90 reorganisations of central government machinery in the last 4 years, costing around £200m per annum. Since 1980, 25 central government departments have been created, including 13 which no longer exist. Capability transformation takes time. It should be planned and managed with respect to each organisation’s future role.

The Review outlined a clear focus on reducing spending, and announced a number of key areas for reform. This is likely to place relentless focus on skills: what skills does government require now and in the future; what is the best mix between in-house and external skills in specific areas; and how can skills shortages be assessed systematically. The objective for public bodies should be to balance a permanent workforce of core skills with capability to introduce specialist or additional skills to deal with specific programme challenges or surges in demand.

It will be increasingly important for public managers to distinguish between the necessary size and necessary shape of organisations. Deloitte believes cutting the first without reworking the second would be a strategic mistake. A key question for reform program leaders is not only “how many people?” but also “how should they be organised?” Keith Leslie, partner in the human capital practice at Deloitte, said:

"The immediate focus for public bodies is to meet budget and headcount targets. But what most organisations need to prioritise is leadership capability to provide direction and motivation through a turbulent few years ahead. Public bodies should also concentrate on reshaping their fundamental operating model. The danger is that by jumping to cuts and new organisation charts public sector leaders will miss the real opportunity to reshape corporate structures to suit citizen requirements in future."

A key theatre of reform will be at local level, which ministers have made clear will be the primary delivery environment for many services in future. Significant cuts and a strong political imperative to do things differently means the stakes are even higher for local authorities. The pressure to manage corporate transformation and drive community engagement will be intense. But there will be opportunities too. Mark Lawrie, Deloitte local and regional government partner said:

“With a 27 per cent cut across the review period (and with much of it front loaded into the first two years) councils face tough choices over where they can roll back operations and stop or postpone capital investment. But even in this environment, there are reasons to be optimistic. The need to reduce costs should accelerate overdue reconfiguration of local authorities into commissioning entities that use new and radical accountability frameworks to drive community engagement in service delivery. Some council responsibilities may be defined in statute, but the method of delivery isn’t. By reviewing their underlying purpose in these terms, local authorities can build the case for rationalising their property portfolios, aggregate corporate services across traditional boundaries and prime their communities to mobilise, and so ‘soften the landing’ as cuts arrive.”

   

3) Management of spending versus cuts

Deloitte agrees that government finance leaders need to play a central role in delivering the austerity agenda. Finance directors should also be central to wider capability transformation efforts as delivery organisations evolve into leaner commissioning bodies. Success in this work depends on strong financial management, sound financial information, and strategic and informed decision-making on asset management and disposals. Finance professionals will have a lead role to play in managing outsourcing programmes and reworking business models to prepare for changes such as new revenue generation.

Our industry insights suggest finance director responses to cost reduction are mixed, with some senior officers unaware or unwilling to play a central role in either managing efficiency or redundancy programmes, or wider capability transformation efforts.

To close this gap, Deloitte has identified a series of areas where improvement is needed to, as the government says in its Spending Review Framework document: “strengthen and re-position the role of the departmental finance director as an enabler of informed decision making at Board level.” Finance professionals within departments and local authorities will need to take on four essential roles: that of a steward, an operator, a strategist, and a catalyst for change across their organisation. These “four faces of finance” should be the driving force being corporate transformation in the public sector:

The Steward role involves managing the assets of the organisation and supervising operational financial management at a detailed level. This work necessarily includes setting high standards of internal controls, and taking personal responsibility to ensure effective budgeting, planning, and forecasting systems are in place.

The Operator function helps ensure prudent use of resources by standardising, consolidating, and automating processes and systems to eliminate duplication. A good ‘operator’ applies forward-looking financial tools such as scenario planning and information analytics to maximise financial resources.

The Strategist role influences the organisation’s overall direction by providing financial leadership for government initiatives. It does so by providing relevant, accurate, and timely financial information to decision makers. A good strategist uses the budget to drive government’s high-level strategy and provides financial analyses to help monitor progress to meeting improved outcomes.

The Catalyst role is chiefly about embedding a financial mindset across local stakeholder and the department more broadly. A good ‘catalyst’ works closely with business areas such as information technology, human resources, procurement, and other functions to drive organisational behaviour and focus on financial management. This includes providing a full suite of services for implementing enterprise-wide financial, HR and revenue systems to support more efficient and integrated operations. A good catalyst also prepares accurate and consistent costing information that is critical to identify opportunities for increasing service delivery efficiency.

In a recent speech discussing the post-Review climate the Deputy Prime Minister said: “Ministers standing at the despatch box will continue to be held responsible for decisions over which they no longer have any control. This will feel uncomfortable, to say the least.” Similarly, for supply and outsourcing reforms to work, finance leaders need to become increasingly comfortable with the idea of partners delivering significant areas of service on their behalf. This will require renewed focus on good governance as the complexity of supply chains increases, and clarity over the overall assurance framework and how it operates in practice. Increasingly, organisations will need to stand back and understand the value of various assurance providers.

Three further specific areas for improvement will be:
•    Improve information integration
•    Knowledge transfer
•    Improve asset management capability

Improve information integration 
With tighter value for money tests on each investment decision, finance directors need to improve the link between financial information and the quality of public service delivery. With increased focus on transparency, ministers and the public will need information on exactly what has been spent on specific programmes, and what value delivery partners bring to each service area. Articulating and measuring the benefits of any given programme will become important.

In response, public bodies will need to bring together finance and operational information to draw better informed conclusions about value for money. Over 50 per cent of departments still report financial and operational performance information to the board separately. Integrating this in information in useable form will be critical.

Knowledge transfer 
Research by the NAO shows that typically, the largest barrier to financial management improvement in the public sector is a lack of awareness and competency outside the core finance team. This is important at all levels, but especially at the top of organisations.

Many central bodies do not include financial management objectives in the performance appraisals of senior officers. This is typically not the case among local authorities, where emphasis on good financial management is in place across senior roles.

Our experience from the private sector indicates that creating close links, interdependent teams and even co-locating the business leader, finance, human resources and internal communications heads, significantly increases the likelihood of success in large transformation programmes. This emphasises the need for stronger business partnering behaviours from finance professionals and several leading organisations have invested in knowledge transfer and coaching sessions for top team members. This activity could be scaled up across the public sector.

Improve asset management capability 
There will be an increasing need for finance directors to improve their understanding of asset utilisation and its value to each organisation. Specific areas for development may include preparing assets for sale by increasing their attractiveness to buyers, and understanding the full range of options between outright ownership and outright sale. Improved management of assets will also extend to intellectual property. Within the government’s transparency commitments, finance professionals will need to consider if the information they hold may be commercially utilised to create revenue streams as organisations become more self-sustaining or privatised.

Across each area, good corporate governance will be essential. Gillian Russell, Deloitte public sector finance partner, said: “In the coming months, when ministers and permanent secretaries want to get a sense of what is possible, they should ask finance directors. Government finance professionals need to step up and play a central leadership role in almost all reforms described in the spending review. As a minimum, they should feel comfortable with the quality and integrity of the information on which they will make business-critical decisions. Their role will increasingly require them to enhance the level of engagement with senior stakeholders in the business, keep close to policy and delivery leads and commercial teams, and develop new management approaches to the changing delivery environment around them."

       

4) Productivity

Because few incentives exist for managers to hold poorly performing staff or organisations to account, there is a limited amount that can be done to tackle productivity shortfall unless the implicit contract between government and public sector workers is reworked.

However, notwithstanding this, there are certainly productivity lessons to be learned from the private sector, where staff work 23 per cent more hours on average (equivalent to 9.2 years of a public sector employee’s working life). Through profit motive private sector organisations are able to measure productivity more accurately and target failings with greater precision. But areas where private firms typically outperform public bodies include a ‘hard-nosed’ performance management system that has universal support, clear links between productivity and reward, and an enriched offering to employees that encourages people to acquire experiences beyond their organisation and to retrain or repurpose their career as required.

During the financial crisis of 2008 the operations of some nationalised British banks were divided into ‘good bank’ - workstreams that managed normal, profitable operations unaffected by the crisis, and ‘bad bank’ to separate and contain problem areas such as toxic assets or redundancies.

Deloitte believes that, from a productivity point of view, the same logic could be applied to departments who are asked to sequence widespread reforms, disposals and redundancies with their business as usual operations. Each area requires fundamentally different management approaches and skills. Specific expertise introduced to manage closures, asset sales and restructuring could be ‘walled off’ to provide better visibility of performance across mainstream operations, and compartment morale-sapping programmes that exist to sell assets or make people redundant.

      

5) Public sector workforce reform

•    Managing Redundancy
•    Behaviour
•    An opportunity to change the rules of the game

Managing Redundancy 
Our view is that, in managing redundancy programmes, public sector line managers typically have little understanding of the legal position; no experience of cost-effectively incentivising voluntary redundancy; may not have previously run an outplacement programme; or acted as an intermediary to match up marketable public sector skills with private sector demand.

If it takes 212 days to hire someone in the public sector, it may take even longer to make them redundant given this capability shortfall. In light of dramatic staff reductions, public bodies may also need to review their ongoing use of surplus pools that appear increasingly anachronistic against private sector equivalents that emphasise compulsory retraining and repurposing of surplus staff.

Our overarching view is that, where possible, inbound headcount reductions should be carried out under the auspices of a calculated workforce strategy rather than through crude downsizing programmes that may be difficult or expensive to implement and may undermine morale across each organisation. Sue Conder, Deloitte human capital partner, said:

“A workforce strategy needs to be considered alongside the outsourcing strategy so that there is a clear view of the critical skills that will be required of civil servants and those skills and capabilities that will be required by the private sector providers. This workforce strategy will also need to be aligned to the new thinking on different ways of organising and delivering work and focusing the headcount cost reduction programs on ensuring the appropriate key skills are retained. Where key skills are outsourced a plan to enable appropriate parts of the public sector to move into the new private sector delivery model will be important to lessen the impact of public sector staff being out of work and enable speedy high performance by the private sector.”

Behaviour 
The change across public sector labour markets attracts a number of risks around staff behaviour. Like any organisation, public workforces include individuals who are productive and add significant value, as well as others who struggle to make an impact or who are unwilling to accept change.

As individuals from the first group leave each organisation, there will be a need to preserve corporate memory on the location of high value assets, key risk areas and visibility over a matrix of third party contracts. For the second group, large headcount reductions bring an increased risk of malicious behaviour that threatens information security, reputation and business continuity. For large transactional businesses, theft or damage to business critical equipment, mass deletion of files and records, or exposure of sensitive corporate information could be extremely damaging.

In response to this, Deloitte believes that there will be an increased need to build an appropriate risk management culture across each organisation. This need arises from the increased dissatisfaction among public sector workers, the delivery of services through dispersed delivery chains cross the public and private sectors and increased sharing of data through shared services. This will increase the likelihood of human error and the need for effective behaviour to manage risks.

An opportunity to change the rules of the game 
Our view is that, given the upheaval across public sector labour market, now is the time to change the core principles under which public sector workers are employed and the way pay and total reward packages are agreed. To tackle poor performance and drive capability improvements, public managers need to dismantle the ‘job for life’ culture that is a key driver of falling productivity across the public sector.

This work should not target the pay and conditions of frontline staff. Rather, it should focus on where the disparity between performance and reward is at its most acute, such as if senior officers in local authorities or departments leave their posts after poor performance, only to reappear in a similar roles where previous pensions and salary arrangements continue.

      

6) A mixed economy of service delivery

Government has a mixed record as a market manager. Clear instances of market failure punctuate the previous 10 years: from systemic failure in long term care, to child poverty, to a list of programme failures brought about by poor contract management and the creation of perverse incentives for suppliers. An enhanced role for the public sector as a commissioner of services as well as an intelligent customer will increase the importance of managing markets effectively.

To achieve efficient and equitable outcomes across new markets and value for money in outsourcing, public bodies could consider new ways to prime, derisk and manage public markets. Competition is shown to have worked best in markets where there is a well developed demand side – that is, customers have perfect information and equal access.

The privatisation of the airline and telecommunications industries in the 1990s illustrate where this was managed successfully. In lieu of these factors, public managers will have to consider how supply and demand can be aligned across emerging markets such as health and social care, education or welfare to produce acceptable and efficient outcomes in each case.

To embed genuine diversity and market mechanisms in to the supply of public services, government has to accept supplier failure – be it a school or social care supplier – as part of the process. To minimise damage to service continuity and communities it will be essential for public bodies to ensure supplier mergers or takeovers of public bodies are as simple and straightforward as possible. Across each new market, a clear ‘provider failure’ response plan will be important.

Supplier management capabilities
Our industry insight suggests that there remains a cultural indifference across public bodies to procurement, commissioning, contract or stakeholder management roles that are viewed as intellectually lightweight and a path to nowhere career-wise.

As a matter of urgency, public bodies now need to introduce structured career paths, board level influence for managers, and proper programmes to develop commissioning and supplier management skills. Management of third parties need to be positioned as an essential experience for bright, ambitious public managers. In the new operating climate, government commercial managers will also need to:

•    Consider corporate responses to increased use of upside quality triggers to drive measurable improved service quality. How this will affect supplier demand for government contracts?
•    Understand how partner appetite for bankable contracts provides opportunities to leverage price.
•    Consider how to transfer a greater share of delivery risk on to third parties. How perennial challenges of principal-agent service delivery such as information asymmetry can be properly managed to end government’s reputation as an ‘unintelligent customer.’
•    Identify where public assets can be made more attractive to private sector firms, and how public bodies can incentivise suppliers to enter into partnering agreements.

Outsourcing and third party delivery is set to grow across public markets but concerns about government’s ability to handle large complex contracts remain in place. As corporate suppliers adapt their offerings to new trading conditions, public bodies should do likewise with their capabilities. This means increased focus on value for money, wider use of measurable quality indicators in standard contracts, and new approaches to influence supplier behaviour. This is difficult, complex work and if public bodies are in any doubt about their ability to execute it, then they must act now to ensure they have appropriate skills in place.

      

7) Wider economic impact

•    Sectoral impact
•    For lenders
•    Corporate responses

Sectoral impact 
With job and spending cuts balanced by growing outsourcing and delivery markets, the economic consequences of the spending review are mixed. There will be significant impact on specific industries such as construction, information technology, or social care and housing providers. Universities and colleges, together with the employment and wealth creation they generate are likely to suffer as higher and further education cuts percolate into regional economies.

But other areas such as health services (at £24.2bn, the largest area of spending on private suppliers) will be insulated through policy commitments. The use of third parties in emerging markets such as education or welfare will provide additional opportunities for corporations. However, mass transferral of public sector staff into the private sector may involve an increased number of TUPE cases for which private suppliers need to be prepared.

In 2011 Deloitte expects immediate cuts to spend on private sector as public managers seek to offset the need to take forward painful headcount reduction programmes to their own workforce. Contract
Contract renegotiations led by the Cabinet Office are underway with around 70 large suppliers to government consulted so far. Following recent press reports, the Government will continue to scrutinise the responses of their suppliers, although ensuring smaller suppliers to larger government contractors are not affected may be difficult to enforce.

More widely Deloitte expects further market exit for suppliers without diverse business portfolios. As headcount reduction programmes begin, and fewer local authority contracts emerge, suppliers to government may face fewer bankable contracts; lower volumes; negative growth and changing customer bases across, for example health and education.

For lenders 
For financial services organisations that invest in, or lend to, suppliers to government there are a series of implications from the Spending Review that include:

•    A need to understand the impact at a granular level – such as the differences between near and long term prospects for outsourcing, or the changing price point of existing contracts.
•    A focus on companies with exposure >10-15 per cent of revenue from the public sector and with inflexible business models.
•    A need to analyse how their customers’ public sector clients will change.
•    Greater scrutiny of corporate business plans to analyse the near term impact of programme cancellations. Lenders will need to assess whether their customers have the balance sheet strength to cope with a period of few and increasingly competitive contract tenders.

Corporate responses 
For their part, ‘Public Services Industry’ players should wake up to the fact that it is no longer 'business as usual' across public markets. New ways of working will produce winners and losers. Those who are prepared to be flexible to adapt to shifting public sector requirements are likely to benefit most.

Opportunities will become available for some firms to support government through new markets as the breadth of business areas considered for outsourcing expands into customer management and other middle office functions. But for those that do business directly with government in established markets, there are likely to be with fewer contracts, lower prices and margins, negative growth, renegotiation of existing contracts and new contract models that link reward to quality or outcome triggers.

The decline in bankable contracts from government may impact on commercial borrowing, and there may be greater risk exposure through more ownership of public service delivery responsibility. Innovation and developing new business models that map to government intent around localism and personalisation will be critical.

Firms that rely on large block contracts to deliver services or manage corporate functions may suffer through the dismantling of sector-wide systems, and erosion of state underwriting and economies of scale as localism and decentralisation create patchworks of service contracts across geographies.

But equally, there may be instances where firms can bid to design, manage and deliver end-to-end services as public bodies seek to offload entire functions. Looking forward, there will also be opportunity for financial services companies to shape the next generation of public-private financing models to introduce greater flexibility on repayments and create stronger links between service contracts and policy outcomes.

spending review

Last updated 539 days ago by Civil Service World