Managing the risks associated with the increased involvement of the private sector in the delivery of government services, in particular the delivery of services through contractual arrangements, will require the development and/or enhancement of a range of skills across the public sector and will be a key accountability requirement of public sector managers. In particular, it places considerable focus and emphasis on project and contract management, including management of the underlying risks involved. The thrust of this change is reflected in the Senate Finance and Public Administration Committee's second report on Contracting Out of Government Services released in 1998:
Despite the volumes of advice on best practice which emphasise the need to approach contracting out cautiously, to invest heavily in all aspects of the process and to prepare carefully for the actual implementation, and the substantial body of comment in reports from the Auditor-General indicating that Commonwealth agencies have a very mixed record as project and contract managers, the prevailing ethos still seems to promote contracting out as a management option that will yield inevitable benefits. Resources must be made available to ensure that contract managers have the skills to carry out the task.102
There is a particular risk that the private sector service provider may have greater information and knowledge about the task than the Commonwealth agency. If they are not to be disadvantaged by this situation, public service contract managers will need a level of market knowledge and technical skills that are at the same level, or above, those prevailing amongst the private sector service providers.
The competent management of the contract is the public sector entity's key means of control over its outputs and their contribution to outcomes. In this context, public sector managers and auditors need to be cognisant of the potential risks that might arise from project management arrangements with private sector investors, such as:
● short term flexibility may be compromised by unforeseen 'downstream' costs or liabilities which erode or offset early gains;
● there may be a tendency for government to bear a disproportionate share of the risks, such as through the offer of guarantees or indemnities;
● the failure of private sector service providers may jeopardise the delivery of the project, with the result that the government may need to assume the costs of completion plus the costs of any legal action for any contractual breaches;
● drafting inadequacies in contracts or heads-of-agreement with partners could expose governments to unexpected risks or limit the discretion of future governments by imposing onerous penalty or default clauses;
● inadequacies in the modelling and projection of costs, risks and returns may, under some conditions, result in an obligation by governments to compensate private sector providers for actual losses or failure to achieve expected earnings;
● there may be some loss of transparency and accountability for disclosure as a result of private sector provider claiming commercial confidentiality with respect to the terms of their investment (this point is discussed further in the next section); and
● the level of private sector investment and the amount of risk private sector providers are willing to bear may be inversely proportionate to the conditions placed on them by governments to determine pricing, delivery of community service obligations, or transfer or sell interest in the project.103
There are also legal risks in terms of determining who is liable for service level deficiencies - these questions bear on the strength and completeness of the contract arrangements. Because outcomes can be difficult to specify (and indeed may even be the combined product of more than one agency) it can be difficult to specify the circumstances in which 'non-performance' has occurred, in order to press for successful contractor performance, given these complex linkages and, moreover, to specify enforceable responses.
That is why it is essential that agencies ensure their staff have the capability and capacities to manage contracts effectively if they are to achieve the results required. It is not just skills in relation to contracting that are important. There is still a high premium on knowledge and understanding of the functions/business that are being managed. Put simply, agencies have to be in a position to know what it is actually getting under a contract and whether it is meeting the set objectives. If they do not, the success of the agency and its very reason for being is put at risk.
Crucial to meeting the challenge is the contract itself and how it is subsequently managed. The prime purpose of a contract with the private sector is to make a legally enforceable agreement. Our audits have clearly illustrated the value of written contracts that reflect the understanding of all parties to the contract, and which constitute the entire agreement between the parties. Otherwise, the documentary trail supporting the authority for the payment of public money and contractual performance requirements, incentives and sanctions may not be clear. Not surprisingly, this is a matter of concern to the federal Parliament, which has been very supportive of initiatives being taken to improve records management.
The contract must clearly specify the service required; the relationship between the parties needs to be clearly defined, including identification of respective responsibilities; and mechanisms for monitoring performance, including penalties and incentives, set in place. However, it should never be forgotten that such relationships are founded on a business relationship in which the parties do not necessarily have common objectives. There should not be any equivocation about required performance nor about the obligations of both parties. Contract management is as much about achieving the desired outcome as it is about meeting particular accountability requirements. Both require sound, systematic and informed risk management which recognises that:
…managing contract risk is more than a matter of matching risk-reducing mechanisms to identified contract risks; it involves an assessment of the outsourcing situation.104
On the issue of contract preparation and management, the (then) Industry Commission (now the Productivity Commission) suggested that public sector agencies tend to transfer as much risk as possible to the agent, thus increasing the risk of contract failure. Conversely, if too little risk is left with the agent, this can lead to poor service delivery and resulting political problems for the government.105 Such political problems reflect the rights of service recipients as citizens who are not party to the principal-agent relationship. This can create other problems as indicated by the following observation:
Probably the greatest accountability weakness, from the standpoint of service recipients and other third parties affected by the actions of a contractor, is the limitation of private contract law in dealing with the interests of parties not covered by the privity of contract between the government agency and the contractor.106
It is recognised that contractual performance is maximised by a cooperative, trusting relationship between the parties. To get the most from a contract, the contract manager and contractor alike need to nurture a relationship supporting not only the objectives of both parties but also one which recognises their functional and business imperatives. It is a question of achieving a suitable balance between ensuring strict contract compliance and working with providers in a partnership context to achieve the required result. According to the OECD:
A good contract is one that strikes, at a level which will be robust over time, a balance between specification and trust which is appropriate to the risks of non-performance but does not impose unnecessary transaction costs or inhibit the capacity or motivation of the agency to contribute anonymously and creatively to the enterprise in question.107
ANAO has conducted a series of audits of recent contracting exercises, with some interesting findings,as follows:
● One agency selected a service provider and advanced funding of 80 per cent of the contract fee to a contractor without checking the financial viability of the contractor. When its financial backers later withdrew, the contractor abandoned the project before it was complete. As a result, the agency terminated the contract and has taken legal action in an endeavour to protect any remaining Commonwealth funds held by the contractor.108
● Similarly, the audit of the $5 billion project for six new submarines found that, although only two submarines had been provisionally accepted by the Navy, 95 per cent of the construction contract funds had been paid over. This was compounded by the finding that the contract only provides the Commonwealth modest recourse by way of financial guarantees and liquidated damages for late delivery and under-performance.109
● An important part of the 1994 sale of the former Commonwealth Serum Laboratories (now CSL Ltd) was the execution of a ten year contract for A$1 billion between the Commonwealth Government and the soon to be privatised company for the supply of blood plasma products. The audit of the sale process found that systems had not been established to manage the risk of overpayments under this contract. A follow-up audit, focusing on the administration of the long-term contract by the relevant public sector agency, found that the management of the long-term supply contract was deficient in relation to the planning and conduct of commercial negotiations over price adjustments. As well, there were inadequate financial controls over the payment of more than $400 million in public funds for blood products. The audit also highlighted the need for corporate governance structures that ensure appropriate action is taken to address issues that are raised by internal and external audits.110
A common theme of these audit reports has been the deficiencies in the project management skills of agency decision makers, allied with the fact that some of these projects involve substantial resources and complexity. As well, similar audits have flagged the need for care in assessing value for money and negotiating, preparing, administering and amending major contracts. The Parliament and the media have also paid particular attention to these issues during recent years, with several agencies receiving significant adverse comments and publicity.
This situation still has to be addressed as a matter of urgency, to reverse these concerns and win back the confidence of all stakeholders. Presently, contracting can be a high risk and costly exercise for both parties. For the private sector, the risks arise from understanding the services to be provided, the attendant obligations and the immediate expense of developing a tender with few guarantees of success. Contractors face the challenge of working in a public sector environment and public servants the challenge of dealing with all aspects of commercial financial viability.
The experience in the UK has been that, while authorities have high expectations at the outset of PFI projects for their success in delivering value for money in public services, the achievement of that value for money is not guaranteed. A 2001 report by the NAO highlighted this issue, noting that:
Authorities need to ensure that the value for money anticipated at the time of contract letting is delivered in practice. To do so requires careful project management and a close attention to managing the relationship with contractors. Authorities also need to consult with users about their level of satisfaction with the services being provided.111
Particularly with large and complex projects there should be provision for contract milestone reviews in the progress of the project, with tests wherever appropriate that prove the progress, and provisions for relief in the event of default.112 However, it has also been suggested that 'contracts should be framed for performance rather than detailing how to achieve this performance.'113
This is an area to which agencies entering into significant contracts with the private sector need to pay particular attention. Even where performance information requirements are set down in the contract, there is a risk that the private sector entity will not fulfil those requirements. In the context of complex, high-cost and high-profile contracts, agencies may not have the leverage needed to obtain timely compliance by the contractor with those obligations. For example, ANAO audits have observed examples of this, as follows:
• In the case of the sale of DASFLEET, the tied contract with the winning bidder for the provision of leased vehicles and fleet management services to the Commonwealth required the contractor to provide regular reports and information to enable the responsible agency to monitor performance by the contractor of its obligations under the tied contract. In lodging its dispute in relation to the tied contract, the agency was of the view that the contractor had not provided reports or information that were sufficient or accurate enough for the agency to monitor the contractor's performance. In addition, there was evidence that many of the invoices provided were also inaccurate. An audit commissioned by the agency concluded that there were serious deficiencies in the information and reports provided by the contractor. The agency advised the contractor that its inability to provide accurate, reliable and complete reports and information was a serious failure to perform fundamental obligations under the tied contract. This issue, together with multiple other disputes between the parties, was ultimately considered in a whole of dispute settlement.114
• The formalised performance reporting generally required of external service providers is an important tool for the effective management of the contract by agencies. However, ANAO's performance audit of the Commonwealth government's IT Initiative identified that, while in each of the three contracts examined by ANAO there had been extended delays in the provision by the contractor of accurate and adequately substantiated performance information.115 The audit found that the provision by the contractor of accurate and appropriately substantiated and detailed invoices had also proven to be an area of difficulty.116 This was despite each of the successful tenderers representing in the tender process that they would be able to satisfy these contractual requirements.
To improve contract management in the Australian Public Service, the ANAO issued a Better Practice Guide on Contract Management, which has received international recognition and is being used by a number of audit offices overseas. The guide emphasises the importance of dealing with risk in contracts. It also emphasises the need to develop and maintain a relationship with the contractor that supports the objectives of both parties and focuses on the agreed results to be achieved, while not ignoring the requirements for parliamentary accountability. For accountability measures to be effective, it is critical that agencies closely examine the nature and level of information to be supplied under the contract and the authority to access contractors' records and premises as necessary to monitor adequately the performance of the contract.
An interesting corollary to the need to ensure that the performance of private sector entities involved in the delivery of government services under PPP arrangements is effectively monitored is the need to ensure the effort involved in achieving that doesn't divert resources from adequate monitoring of, and accountability for, continued public sector service delivery of similar or related services. For example, in 1999, the then Victorian Auditor-General found that due mainly to a need to direct scarce resources to the monitoring of three private-operated prisons opened following the introduction in 1994 of amendments to the Corrections Act 1986, the Commissioner's Office had undertaken very limited monitoring of the State's 10 public prisons in recent years.117