Missing the wood for the trees

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Missing the wood for the trees

This post is from The King's Fund Blog

In his economics course at Columbia University, Joseph Stiglitz invites his students to participate in an auction for the money in his wallet. The smarter students keep their heads down – Stiglitz won his Nobel Prize for studying missing information in market transactions, after all. But there are always a few students willing to take a bet on how much cash Stiglitz has on him. If the winning bid is lower than the contents of his wallet, he declines the trade. If it’s higher, he accepts – although persuading the ‘winner’ to honour the agreement turns out to be equally challenging.

In 2013, commissioners and providers in Cambridgeshire and Peterborough replayed Stiglitz’s wallet auction on a grander scale: the procurement process to award a new five-year, £725 million community services contract. The clinical commissioning group (CCG) received 60 expressions of interest and shortlisted 10 consortia, before selecting UnitingCare – a partnership of two foundation trusts – in October 2014. UnitingCare’s final offer was £27 million less than the lowest of the offers from other bidders.

Nobody, it seems, was quite sure what they were bidding for. Even the incumbent provider was unsure how much it cost to deliver the services. None of the bidders could be sure how quickly they might reduce costs or improve outcomes. There must have been comparable uncertainty about how any number of factors (such as population needs, treatments, input costs) might change over the contract period. The deal collapsed after only six months, an inevitability once the gulf between funding and costs became apparent.

There have now been three reviews of why the contract fell apart. The report from the Public Accounts Committee (PAC) published in November is excoriating, decrying ‘gross irresponsibility’ and an ‘astonishing array of errors’ in contracting. And PwC’s review makes dozens of recommendations for future procurements, including stronger governance, more rigorous scrutiny, more experienced staff, better commercial advice and more training.

The government’s response has been to strengthen the oversight of complex procurements. In its evidence to the PAC, NHS England identified seven key lessons including the need to develop the NHS’s commercial skills, design the service correctly from the outset, gather transparent cost information, and set appropriate terms at the start. Under its new assurance framework, commissioners will need to answer 65 questions before they can proceed with complex contracts in future. There are dozens of requirements for ‘robust’ plans and assessments. Commissioners will need to provide 16 submissions to pass just the first of three checkpoints, with requirements for the others yet to be revealed. One senses the national bodies’ desperation to avoid further embarrassment, but also a lack of clarity about where the real problems lie.

All of this seems a recipe for transaction costs to spiral out of control. Commissioners spent £6 million on the UnitedCare procurement. Providers will have spent large sums too. How much higher will these costs be once commissioners have prised experts away from other sectors, purchased more comprehensive advice and run the gauntlet of the new assurance regime? How long before the PAC starts to question the proportion of NHS resources being siphoned off in transaction costs, often simply to apportion risk between two parts of the public sector whose profits and losses ultimately lie on the same balance sheet?

As the reviews identified, uncertainties that remained unresolved at the bidding stage contributed to the UnitingCare failure. In these circumstances, it is well known that competitive processes, rather than identifying the most competent provider, often select the bidders with the least rigorous calculations, the most over-optimistic assumptions, or those planning to renegotiate terms once the contract is signed (in this case, all three). If we just invested more upfront – to pursue the regulators’ logic – we could iron out these uncertainties and lay the foundations for an effective competition.

However, even military-grade commercial skills seem unlikely to address many of the uncertainties inherent in these contracts. Sure, it should be possible to avoid mistakes such as forgetting VAT liabilities. But will commissioners ever be able to ‘design the service properly from the outset’, develop a ‘full understanding of contract risks’, or set ‘appropriate terms’ for 10-15 year multispecialty community provider or primary and acute care system contracts? For such long periods, many of the questions in the assurance framework may simply be unanswerable.

There is an alternative to the arm’s race being proposed. In similar circumstances, experts in other sectors invest less rather than more, attempting to clarify uncertainty upfront, focusing instead on procurement processes and payment mechanisms that cope better with uncertainty while minimising transaction costs. In doing so, they recognise a trade-off between the incentives for providers to improve created by tendering, and the costs of managing these procurements, developing contracts and monitoring performance.

In construction, defence and manufacturing, purchasers are more likely to invest in developing detailed specifications, hold competitive procurements and award fixed-price contracts for simpler projects – those where it is easier to develop a complete design and observe providers’ performance. However, they invest less in upfront design, forego competitive procurements, and rely on softer incentives for more complex projects. In construction, for example, private purchasers are more likely to negotiate with a preferred supplier and agree ‘cost plus’ contracts for complex projects, where the biggest concern is costly negotiations on design changes once the contract is agreed.

Studies highlight stark differences between public and private purchasers, with the private sector much more sceptical of tendering. In the US, public purchasers tender for 97 per cent of construction projects. Private purchasers negotiate with a preferred supplier for 44 per cent of projects, holding fully open competitions for just 11 per cent.

If the NHS is committed to learning from best practice, these examples suggest that it should reflect carefully on the procurement process rather than simply spending more on commercial skills or iron-cladding its due diligence. NHS commissioners have less flexibility than private purchasers. However, even under current procurement rules, there is scope for commissioners to pursue negotiations with a preferred provider to deliver integrated care, particularly where incumbent GPs or hospitals need to play a central role, rather than open tenders that allow transaction costs to explode.

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