GOVERNMENT CONTRACTS: THE NEXT GENERATION
LESSONS FROM THE “REVIEW OF GOVERNMENT CONTRACTS”

Presentation to
IPAA breakfast seminar

By Wayne Cameron,
Auditor-General of Victoria

3 October 2000

Presentation content

• Review by Professor Russell's team

• Comments by this Office on contracting

• General observations on contracting in Victoria

• Observations about public/private partnerships

Russell Review – Why was it necessary?

• Fear of the unknown – A new government coming to power not unnaturally wants to know the full extent of future financial commitments and exposures, the status of capital works in progress and whether there exists any disputed areas in major outsourcing contracts.

• Any new government wants to establish a base level of confidence in the internal processes over contact management. An independent audit such as this does just that.

• A cross-departmental review such as this provides an opportunity to re-examine existing public sector business processes and to consider whether there are any policy, leadership, administrative or governance gaps that need attention.

• lt also provides an opportunity to lift the level of consciousness of public servants in understanding the special risks attaching to contracting, including probity. Today's forum is testimony to this point.

Auditor-General’s observations to Parliament

Reports by this Office over the years have included comment on contracting processes. Set out below are some examples of matters reported to Parliament in recent times.

• Absence of cost-benefit analysis. For major consultancies, detailed cost-benefit analyses are all to frequently not undertaken as an important precondition to a project proceeding. Frequently fully costed “make” or “buy” evaluations are not compiled. Where they are, it is important to ensure that the full costs of the internal delivery option are included. For example, the full use of departmental facilities, administration, in-house resources, as well as the direct costs. Instances have been identified where these elements of cost have not been included and only the fee payable to the consultant has been included in the analysis.

• Identification of conflicts of interest. Generally, contracts entered into with consultants have included a conflict of interest clause. However, in some cases, no evidence exists to show that departments have requested details of current or potential conflicts of interest where consultants have been engaged. Departments need to ensure that pre-engagement practices ensure that conflicts of interest are identified and assessed at an early stage so as to avoid nugatory effort.

• Competitive and public tendering processes Competitive and public tendering processes have not always been applied when procuring consultancy and contractor services, although justification for not doing so has been documented.

• Approval to engage consultants. Instances have been identified where departmental guidelines for engaging consultants have not been complied with. This includes where contracts have been entered into prior to obtaining the Secretary's approval.

• Use of a probity auditor. In many cases, the tendering process has not been subject to an independent probity audit in order to attain independent assurance over the fairness and equity of the tendering arrangements. In other cases, although a probity auditor has been appointed, written probity reports have not been prepared for all phases of the tendering process.

• Evaluation criteria. Weightings have not always been assigned to evaluation criteria, and cost has often been given emphasis over other selection criteria.

• Clear lines of responsibility Poorly structured contracts with blurred lines of responsibility have led to protracted and costly negotiations and disputes on remediation work.

• Performance measures Performance measures are often not defined in terms of business objectives, i.e. they don't cover key elements of the contractor's performance and are not based on reliable data. Once established, measures are poorly monitored. Inadequate performance criteria have been a very common weakness. Low level quantitative measures have characterised a lot of contracts with little attention to assessments of the impact of contractual arrangements on quality of services or effectiveness outcomes. In such cases, the monitoring position of agencies has also been weakened.

• Communication with tenderers. Instances have been identified where communication, including verbal discussions, with tenderers has not been formally or adequately documented to support decisions made in the tender process.

Elements of good contracting practice

Optimum outcomes in contracting can only be achieved where all parties, including government, suppliers and taxpayers have a clear understanding of, and confidence in, the processes engaged. To facilitate such outcomes:

• The Government's contracting procedures and policies need to be effectively communicated to all relevant parties. Communication can be facilitated through various forums, such as this one or other training forums, or networking for experience sharing to reinforce key principles. Care also needs to be taken to ensure that such procedures and policies are internally consistent where they are promulgated by more than one agency (e.g. the Victorian Government Purchasing Board, separate divisions of the Department of Treasury and Finance, separate purchasing units within departments etc).

• The behaviour of government agencies throughout the process needs to be governed by ethics, which are driven by the principles of fair play, openness, consistent treatment and honesty to all parties.

• Government/agency decisions to proceed with projects and the mode of project delivery (e.g. in-house versus outsourcing, private sector financing etc.) should be supported by comprehensive cost-benefit analyses. Agencies should retain clear and comprehensive evidence; usually a sound business case will suffice, to justify the contracting decision. The evaluation of potential service delivery options and the rationale supporting the final choice should be robust and transparent.

• Contracting/tendering processes need to be open and transparent. That is, the processes and selection criteria need to be established at the outset, clearly communicated to all parties and observed by the relevant government agencies – Probity in contractor selection is critical to a supportable and fair process.

• Competitive tendering processes should be established wherever possible to ensure greater transparency and justification of outcomes achieved.

• In relation to major contracts/privatisations, consideration needs to be given to engaging external and independent probity auditors to oversee the probity of the process and provide assurance as to its fairness to all parties. Remember, fairness is often a perception issue.

• A key element of the tender selection processes needs to include the conduct of appropriate probity checks of tenderers (i.e. financial viability, conflicts of interest, qualifications etc.).

• Where in-house bids are allowed, appropriate probity arrangements need to be established prior to tendering to ensure that in-house parties do not have unfair advantage compared with external bidders, conflict of interest situations are avoided, and other risks inherent in such arrangements are adequately identified and managed. Such arrangements need to ensure (among other things) that in-house bidders are not involved in the establishment and management of the tender process.

• Consideration could be given to the establishment of more panels of contracts with short duration (say, 2 to 3 years maximum), with agencies able to choose from those panels of approved suppliers and avoid high costs of tendering in every case.

• Where consultative processes need to be established and followed, due process should not be a casualty of convenience. That is, it is not sufficient to merely “go through the paces” to create the perception of compliance. Rather, the processes should ensure that sufficient time and resources are available to provide all parties an appropriate opportunity to make value-adding contributions to have their “considered” say on the key issues.

• Contractual documents (where appropriate) should provide access rights for the public sector agency to relevant private sector records, and to facilitate the provision of audit assurance on pertinent information on which public sector agencies may place reliance to support payments or assessments of compliance with contractual arrangements.

• Contacts should clearly specify the key deliverables to be provided by the private sector providers and the rights and responsibilities of the respective parties.

• It is important to develop robust service level agreements that define service expectations from the commencement of the service. It is critical that:

• definitions of service are provided;

• requirements and expectations are specified

• key performance indicators (KPIs) and other measures are set; and

• relationships between the agency and the service provider are defined, including with second level service providers such as sub-contractors.

• Contracts need to include provision for the GST.

• Although cost and quality are key considerations in tendering/contracting, contractor evaluations also need to have appropriate regard to the achievement of other important objectives, which could include such areas as: safety, certainty of supply, environmental responsibility, contribution to regional development, “local content”, access to training etc.

• Where possible, appropriate incentive and disincentive regimes should be established within the contractual arrangement to drive and direct contractor behaviour to focus on the delivery of key outcomes, including cost, quality and quantity of service delivery, public safety, environmental etc. Such regimes need to be effectively managed by the relevant public sector agency to ensure all expected outcomes are achieved and risks are mitigated (effective risk management is critical).

• Where major contractual extensions are required which substantially change the scope and value of the initially contracted works, consideration needs to be given to the re-introduction of competitive processes (i.e., a low value contract should not be extensively extended without re-tendering – given that such a process gives the initial contractor an unfair advantage over other parties). Many agencies use a “rule of thumb” of 10 per cent of the existing contract value for extensions.

• Risk allocation between the private sector and the public sector should be based on the principle of allocating risk to the parties best able to manage such risks. It is important to remember that, while some risks and responsibilities will be transferred to contractors, government is not relieved of the fundamental responsibility and accountability for the cost and quality of delivered services. As such, agencies should always be in a position which enables adequate protection of the State's interests (without unduly interfering with the rights and operating requirements of contractors). In relation to long-term contracts, business continuity issues should be evaluated at regular intervals throughout the contract to ensure delivery. Also, built into these contracts should be appropriate decision points in the course of the contracts to provide government with the ability to review the service delivery options in certain circumstances/events.

• Outsourcing does not mean lack of management. Appropriate in-house (quality assurance and risk management) processes need to be established and resources committed to ensure that the key deliverables are achieved. At the end of the day, it is the public sector agencies themselves that are ultimately accountable for the delivery of the outcomes.

• Post-contract evaluation – Contracting agencies should assess whether the benefits sought from contracting have been achieved. To assist such an evaluation baseline quality standards and costs should have been defined for current service prior to contracting arrangements being entered into.

Private/public partnerships

Given the recent discussion on the continued involvement of the private sector for what essentially is the supply of public service, I thought it might be instructive to make some brief observations from the United Kingdom experience.

• The UK's PFI experience: Mixed. Recent rail disasters have raised questions about the risk and benefits of PFIs.

• There may be some lessons here for us to draw on as we manage existing outsourcing contracts and contemplate public/private partnerships to deliver public goods and services.

• One thing is clear about PPPs and that is that the political risks are not transferred through PPPs, and neither is the public interest lessened. Other risks include public safety risk, public consumer risk, environmental risk, public consultation risk, transparency risk, and public confidence risk.

• The dominant theme is that while services might be outsourced effectively, some risks cannot.

• Outsourcing or partnering arrangements need to be carefully constructed, with plenty of consultation with interested/affected parties to ensure the performance parameters (including the related incentive/disincentive regimes) are carefully thought out and that they encourage the desired behaviour/ outcomes both in financial and non-financial terms.

• UK experience suggests 2 criterion for consideration:

• Ascertain level of public and political profile and weight the risks attaching to outsourcing accordingly; and

• Assess intangible impact, e.g. public safety, environmental risk.

• Some risks can be transferred, but where services are high profile and involve public safety, the public sector bears the risk.

• High risk, high visibility profiles require careful tailoring and management

• Greater transparency to maintain public confidence, e.g. evidence of risk control and mitigation;

• Flexible decision points allowing the periodic and pro-active re-assessment of aspects of the arrangements if things go wrong; and

• Balance the risks between the players in a way which ensures that those best able to manage the particular risk can.

• Where risks are high – a shared approach to testing and piloting may be necessary to engender public confidence.

• Risk management plans need to be developed with the service provider and should identify significant risks, likelihood of occurrence and means by which they can be managed.

• It is also important that contingency plans for key services are in place to accommodate issues such as continuity in the event of contract termination, or non-renewal at contract expiry date.

A tailored approach to mitigating risk in PPPs

• Procuring authority will maintain a more active role in service management than lower risk outsourcing contracts.

• Greater and earlier involvement of bidders is required to ensure they really do understand the service risks and can demonstrate their risk mitigation strategies.

• Performance review and payment arrangements need to ensure the appropriate performances deliverables (financial and non-financial) are encouraged and rewarded.

• Reward innovation where intangibles (such as public safety) are adequately factored in.

• Ongoing evaluation of business continuity risks is necessary.

• Risk assessment and allocation, including intangibles, should be signed off by all concerned – department, contractor, politicians, before contract awarded.

• Managers on all sides to agree plans to manage public and political perceptions as program progresses.

Concluding remarks

Substantial progress has been made by the Victorian public sector over recent years in the development and implementation of contracting frameworks and arrangements. It is clear from the foregoing, however, that there remains substantial scope to further improve contracting practices and processes. The work undertaken by Professor Russell and his team, and the presence of those here today, provide an opportunity to extend the proficiency of the public service in this important area.