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Outsourcing financial services is an accident waiting to happen

The collapse of Mouchel brought the pitfalls to outsourcing financial services into stark relief, writes Peter Bateman

THE PACE OF CHANGE in public services and the financial squeeze on local authorities are unrelenting. While the outsourcing of transaction-based financial services (creditor payments, benefits and so on) has been going on for years, a number of local authorities, seeking further savings and efficiencies, have now outsourced what were once regarded as core functions. Accountancy is a good example.

The fact that outsourcing of financial services can bring major benefits is not disputed. Outsourcing deals for accountancy have enabled major investment in new systems, and have enabled local authorities to tap into knowledge and expertise that would not otherwise have been available to them. The cost savings are only part of the overall benefits. There are, however, downsides to all this, and the experience to date has highlighted two in particular: aggressive cost cutting by contractors affecting service quality and concerns about the financial viability of those contractors.

The collapse of outsourcing provider Mouchel at the end of August of this year threw these difficulties into sharp relief. Mouchel has in the last ten years established itself as a significant player in the market. Its February 2012 contract to provide Bournemouth Borough Council with finance and accountancy services, having already agreed to provide services in ICT, revenues, benefits and facilities management in 2010, proved particularly controversial.

The decision to award the contract was overshadowed by the suspension of chief accountant Stephen Parker for raising awkward questions about both Mouchel’s ability to deliver the service and also about the company’s financial stability. He was subsequently reinstated. This second concern has proved prophetic.

In August, Mouchel’s assets were transferred to MRBL Limited, a new company owned by affiliates of its lenders – RBS, Lloyds Banking Group and Barclays – and the group’s management team as part of a pre-packaged administration, creating the paradoxical situation of privatised services being taken over by what is effectively two state-owned banks (plus Barclays). It may be assumed that the banks’ main concern will be to get out again as quickly as possible and that any sale may involve breaking up the company, generating further uncertainty for its local authority clients. There have been calls for Bournemouth to take financial services back in-house. Days before the pre-pack was announced, Milton Keynes Council announced an early termination of its 12-year deal with Mouchel, which was signed in 2004. Under the proposals, the council would bring its outsourced support services back in house, converting the contract into a framework that would run through to 2018.

Potential for conflict

While private companies may underbid, there are frequently unrealistic expectations on the part of local authorities that do not understand the commercial environment. Most expect savings of 10% from outsourcing but also investment up front, which means that the costs are frontend-loaded for the provider. To generate a return, costs – such as staffing – may be cut too aggressively with a possible impact on service quality.

If a provider is struggling to generate adequate returns on a significant number of contracts, there will be problems. Mouchel was an accident waiting to happen. Many local authorities had no arrangements for monitoring partners’ financial stability after the pre-contract due diligence and no effective contingency plans to ensure continuity of service provision.

Some councils have hesitated to outsource accountancy services on the grounds that they are a strategic function unsuited to external provision. It was for this reason that Middlesbrough Council brought accountancy services, previously outsourced to Mouchel, back in-house in June 2011, while extending its contract with Mouchel for the rest of its financial services for a further five years.

There is a clear potential for conflicts of interest when Section 151 officers of a local authority – usually an FD or a treasurer – are supported in carrying out their statutory duties by professional accountants who are on the payroll of one of the council’s major suppliers. However, many councils seem reluctant to say what they are doing to mitigate the risk.

Outsourcing can also be subject to the law of unintended consequences. According to the head of finance of a district council in the South East, meeting the targets for cuts was proving a headache. Many services had been outsourced and were subject to RPI-based contracts, and the cuts were having to be borne in full by the services still provided in-house, leading to distortions in resource allocation. Outsourcing of financial services to realise savings in back-office functions and protect front-line services might, paradoxically, have the opposite effect.

How, then, do you outsource without coming to some sort of grief? Firstly, have realistic expectations. Secondly, ensure sufficient expertise is retained in-house to enable effective contract management. Thirdly, do not commit to a private sector provider for excessively long periods of time since any arrangements imply a loss of control and flexibility. Finally, have a contingency plan so that you can, if necessary, take the service back in-house. In short, be smarter. ?

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