Capita – an NAO insight.

By Tony Collins

Capita is a remarkable success story. Formed in 1984 with two people, as a division of the Chartered Institute of Public Finance and Accountancy, it grew rapidly to become a FTSE 100 member in 2006. In 2012 its turnover was £3.35bn, its pre-tax profits were £425.6m and it employed 52,500 people. It now has 62,000 staff across the UK, Europe, South Africa and India. It  acquired about 36,000 staff through TUPE.

In a survey, 71% of Capita staff agreed with the statement that “Overall I feel Capita is a good place to work” and 85% have an overall satisfaction with management.

The company’s  public sector turnover in the UK is about £1bn, divided roughly equally between local and central government. Two of its most recent UK contracts are at Barnet Council.

Yesterday the National Audit Office published an insight into four companies, Capita being one, after a request by the chair of the Public Accounts Committee, Margarget Hodge. She is not so impressed by Capita’s success.

“I asked the NAO to carry out this work after looking at case after case of contract failure- G4S and the Olympic security, Capita and court translation services, Atos and work capability assessments, Serco and out-of-hours GP services, to name a few.

“In each case we found poor service; poor value for money; and government departments completely out of their depth,” said Hodge.

Capita, however, comes out of the NAO investigation fairly well, better than the other three companies (G4S, Serco and Atos) but the NAO made some general points, unspecific to any of the four contractors, that indicate contracting arrangements between government and some of its major suppliers are far from ideal.

One of the NAO’s findings is that some suppliers may be “too big to fail” – and “difficult to live with, or without”.

The NAO memo provides information on Capita that would not otherwise be in the public domain. The audit office based its information on interviews with suppliers and civil servants, surveys, company reports, data from “open book” accounting and Cabinet Office files.

The four suppliers co-operated with the NAO but not completely. Where the contract did not have “open book” clauses Capita did not provide information on its costs or profit margins.

Below are some of the NAO’s findings in its “Memorandum on the role of major contractors in the delivery of public services”.

Capita has contracts with most major central government departments. In 2012/13 these contracts by value included:

Department for Work and Pensions: £146m.

Home Office: £99m

NHS: £71m

MoD: £40m

Department for Transport: £28m

Ministry of Justice: £23m

Cabinet Office: £19m

Department for Education: £17m

Department for Business Innovation and Skills: £11m

Department for Culture Media and Sports: £5m

DEFRA: £5m

Department for Energy and Climate Change: £3m

Department for International Development: £2m

HM Treasury: £2m

HMRC: £1m

Department for Health: £1m

Capita’s profits

The NAO says:

“Capita has been profitable for many years. Its accounts allocate its activities to 11 operating segments according to the nature of the services provided. All of these operate globally and contain at least one public sector contract as well as UK private sector and overseas work.

“The information that we saw at Capita indicates the following

• Public sector work generally has a margin, before both divisional and global overheads, of 6 to 18 per cent, falling to between 1 to 10 per cent once overheads are included. Capita told us that its other public sector contracts would be similar, but that they were ‘doing better’ in the private sector.

• Two contracts reported a loss. Capita said this was because costs such as investment were being incurred at the start of the contract. Capita told us they expected these contracts to achieve a whole-life gross margin of at least 15 per cent.

• Some contracts had higher margins. Capita told us these were older contracts, some of which had made losses early on.

“Capita only showed us information on contracts that had open-book clauses. They believed that most of their clients regularly use open-book access rights. It  [Capita] said: ‘We do not distinguish between public and private sector contracts in our internal management information systems and it would be additional work for us to make available the information in a comparable format.’”

Capita’s UK taxes

The NAO estimate Capita’s UK tax paid in 2012 was £50m-£56m.

Below are some of the NAO’s general points that are not specific to any one of the four companies.

Making money through contract changes

NAO: “Changing a contract and adding requirements allows a contract to evolve, but can be less competitive than fully tendering the new requirement.

“Because of such changes, the total revenue through contract tends to grow, as reflected in the four contractors’ portfolios. In our experience the contractors tend to make higher profit margins on these changes. Good practice aims to build flexibility to the contract and relies on transparent costs and profits…

“Generally contractors manage their profit across a portfolio, targeting an overall level of profit. Low margins are often established during the bidding process, but can increase during the contract lifetime.”

Easier to stick with existing suppliers?

“Incumbents can be seen by procurement and policy officials as the easier and safer option. Across the 15 applicable services we looked at as case studies for this memorandum, seven had been re-tendered at least once, with four of the most recent competitions for each service being won by existing providers and three by new providers.”

Open book accounting not always open

“The government only has access to information on the profits contractors make where ‘open-book arrangements’ are written into contracts. Open-book arrangements either require the contractor to update the client department regularly on their costs and profit, or allow the client to audit those costs and profit on an ad hoc basis.

“We found that use of open-book access rights varies. Some public bodies do not try to see data on contract profits. Comparing profit levels from the open-book arrangements we reviewed also posed challenges as contractors vary in how and when they allocate central overhead costs against profits from contracts…

“We do not have direct audit rights over government contractors. It is normal, however, for government contracts to require the contractor to give us information and help when we audit that public service and government entity. Where there are open‑book accounting arrangements with the government then this includes making those available to us.”

Suppliers pass risk back once contract start?

The original allocation of risk in the contract often changes once the contract starts. For instance:

• Contractors will often pass risk back to clients who do not fully enforce or carry out their part of the contract. The government department therefore needs the appropriate skills to manage the type of contract it is using.

• The original understanding of the risks in the contract may prove to be wrong. This can lead to the contract being terminated (Figure 18) and risks that the government thought the contractor would manage returning to the public sector.

• The government sometimes ignores the commercial terms and risk allocation in the contract when trying to settle a dispute or vary the requirement. Instead, it can put political pressure on the contractor and threaten their reputation

You can’t rely on contracts

The standards expected of all public services are honesty, impartiality, openness, accountability, accuracy, fairness, integrity, transparency, objectivity, and reliability, says the NAO. They should be carried out:

• in the spirit of, as well as to the letter of, the law;

• in the public interest;

• to high ethical standards; and

• achieving value for money.

In these respects public contracts are limited in what they can achieve. Says the NAO:

“Many of the standards expected of all public services do not easily translate into a contract specification. It is not possible, for instance, to contract for ‘integrity’ or the ‘spirit of the law’.

“Achieving the standards expected for public service depends largely on the corporate culture, control environment and ethics of the contractor. It is not easy, however, to use contract negotiations to meaningfully assess and set standards for the contractor overall.

“Government therefore needs to supplement traditional contractual mechanisms with other means of ensuring the expected standards are met. In particular, they need to ensure that the companies’ own corporate governance, management and control environment are aligned with taxpayers’ interests.

“This requires both transparency over performance and incentives to implement the rigorous control environment required including credible threat to profits and future business if problems are found.”

The NAO says officials need to better understand the general control environment that contractors use to manage government contracts, and how far senior executives in those companies should understand what is happening within their companies.

US is more open than UK

The NAO says that companies’ own public reporting and transparency to the public is important to facilitate public scrutiny and trust. Although the government publishes new public contracts on its website www.contractfinder this contains only recently awarded contracts and “very few of the four contractors’ contracts are on it”, says the NAO which adds:

“By contrast, the US government website www.USAspending.gov sets out the full contracts and spending on all government suppliers.”

On Freedom of information, contractors compile information to answer freedom of information requests when asked by their government clients, where they hold the information for the government, but the department answers the actual request.

Says the NAO: “Freedom of information does not apply to the contractor’s business and commercially sensitive information can be exempt.”

On the openness of suppliers in reporting profits the NAO says:

“Even where transparency exists, it is inevitably difficult to interpret profit information. It can be unclear what a reasonable margin looks like. In theory, the margin is meant to reflect risk, innovation and investment. But these are difficult to measure. Furthermore, profit is rarely presented consistently. It can be unclear how overheads are allocated. The profit margin changes, depending on the stage of the project. And different companies may target different rates depending on their business model.”

KPIs of limited value

The NAO says KPIs give a limited overview of performance and are normally focused on things that are easily measurable.

“The main way the government can gain quality assurance is through the contractual reporting. This normally includes a set of KPIs that track performance and that are often linked to financial incentives. Together these make up the service level agreement (SLA). These can be used effectively to manage performance. However, there are three major risks that mean that contractual reporting is not sufficient on its own to monitor performance.”

The NAO says there are risks of misreporting. “There have been instances of contractors misreporting performance, including the case of Serco’s Cornwall out-of-hours healthcare contract …”

Poorly calibrated KPIs.  

“All the contractors told us about instances where poor calibration has resulted in green SLA traffic lights where the client is unhappy or red traffic lights where the client is content with the service. This reduces the SLA’s relevance and can indicate that incentives are not working.”

Are some suppliers too big to fail?

“The current government, like the one before it, sees contracting out as a way to reform public services and improve value for money. Contracting out can significantly reduce costs and help to improve public services. However, there are several indications that better public scrutiny is needed across government contracting:

• There have been several high-profile allegations of poor performance, irregularities and misreporting over the past few months. These raise concerns about whether all contractors know what is going on in their business and are behaving appropriately; and how well the government manages contracts.

• The government believes that contractors generally have often not provided sufficient value, and can contribute more to the overall austerity programme.But the general level of transparency over contractors’ costs and profits is limited. The government needs a better understanding of what is a fair return for good performance for it to maintain the appropriate balance between risk and reward.

• Third, underlying both these issues is the concern that government is, to a certain degree, dependent upon its major providers. There is a sense that some may be ‘too big to fail’ – and difficult to live with or without.

Can we see whether contractors’ profits reflect a fair return?

The NAO’s answer to its own question appears to be “no”.

It says there is a need to explore further:

• Whether there is sufficient transparency over costs, profit and tax.

• Whether the balance of risk and reward is providing the right incentives

for contractors.

• Whether profits represent a fair return.

Shareholder v taxpayers’ interests

The NAO suggests that suppliers are likely to put their own interests before taxpayers’.

“Companies’ own control environments will likely concentrate on maintaining shareholder value. Government needs to ensure that it is in the contractors’ financial interests to focus their control environment more widely on meeting the standards expected of public service.

“This involves using contractual entitlements to information, audit and inspection to ensure standards are being met. And it is likely to involve financial penalties, banning from competitions and political fallout when problems are found.”

The NAO says that, to be a well-informed customer, the government needs to satisfy itself that contractors’ corporate governance structures work in taxpayers’ interests, and that the companies are not paying ‘lip service’ at the centre with little group-wide control to back it up.

“Companies that are large and have sprawling structures, involving a vast number of subsidiaries, may have to make particularly strenuous effort to demonstrate this.”

The NAO suggests further areas to explore:

• Whether contractors are meeting the standards of performance the public expects.

• What contractors consider themselves accountable for.

• Whether transparency is sufficient to ensure contractors work in the taxpayers’ interests.

• Whether contractors’ control environments focus on ensuring standards of public services are met.

Supplier information unverified

The NAO says: “We are grateful for the help and cooperation provided by Atos, Capita, G4S and Serco in the preparation of this memorandum. Most of the information in this report is based on information the companies provided.

“Much of this would not otherwise be in the public domain. The contractors also helped us to understand their business and talked frankly about the risks, challenges and incentives they face.

“However, we do not directly audit these companies and have not been able to verify all the information provided against underlying evidence. We have therefore presented the information in good faith, and attempted to compare different evidence sources wherever possible.”

NAO memorandum on the role of major contractors in the delivery of public services

Comment

Capita is not a bad government contractor.  Perhaps it is one of the best. But is that a ringing endorsement?

The NAO has carried out a thorough investigation but its inquiry suggests that much about public sector contracting remains hidden. On suppliers in general, it is not difficult, if both sides tacitly agree, to hide problems from Parliament, the media and even the Cabinet Office which asks the right questions of departmental officials but does not always get answers, let alone accurate answers.

The NAO did not always get answers to its questions. Indeed Amyas Morse, head of the NAO, said there is an impression that some officials are not in control of their suppliers.

“Contracting with private sector providers is a fast-growing and important part of delivering public services.  But there is a crisis of confidence at present, caused by some worrying examples of contractors not appearing to treat the public sector fairly, and of departments themselves not being on top of things.

“While some government departments have been admirably quick off the mark and transparent in investigating problems, there is a clear need to reset the ground rules for both contractors and their departmental customers,” said Morse.

My thanks to campaigner Dave Orr for drawing my attention to Morse’s comment.