How a local authority might develop a BS venture

Smalltown District Council (SDC) is a relatively small council close to the borders of a large provincial city. The chief executive of SDC believes that the problems they face are getting worse month by month. A project starts with the express aim of establishing which processes should continue in house and which would be done better if they were transferred to external specialists. Eventually, the project management committee reports that in a number of areas of work where information systems are involved, the externalization option should be seriously considered. Other areas not involving IT are recognized as potential candidates for outsourcing but there is general agreement that all these activities should continue in house until the IT requirements are fully understood and accounted for.

Following this conclusion SDC decides to begin a BS programme. It is informed that the first step in the programme is to set out all its key business processes and, if possible, separate them under their controlling functions. The object is to find those processes that are failing or likely to fail completely within, say, a three-year period and to see if it is possible to find a partner or partners for these services.

When the areas using IT were rated in terms of ’the most urgent to deal with’, the most important area turned out to be Housing Benefit. This was surprising in some ways, in that this service had actually been outsourced four years previously and was the authority’s only experience of outsourcing. Furthermore, the arrangement was proceeding according to plan and was showing SDC reasonable savings when compared to the last in-house costs.

The problem currently faced by SDC in this area is that they now think that they are being seriously overcharged. Normally speaking, a function as relatively small as housing benefit would not be outsourced in isolation from other similar business processes. SDC took the step to outsource almost in desperation. A few years previously the council had been subjected to a number of unforeseen problems, including an unexpected influx of people from outside its own boundaries. The result of this was that claimants were waiting excessive periods of time to make claims and would often return several days after making the original claim, only to find that their details had not yet been entered into the system.

After studying the situation in 1996, SDC was convinced that it should immediately outsource this function. However, the operation was relatively small and only one service provider expressed serious interest. When this provider finally took over responsibility it quickly involved document image processing (DIP) specialists. The result is a system in which the claimant is directed to a small desk in the authority’s main reception area where the relevant benefit claim details are immediately scanned into a computer. Then, by the time the claimant has reached the main housing benefit desk, the details are up on the screen and the claim can be processed.

The contract has one year to run and the service provider has already informed SDC that it would be willing to sign a further five-year contract at the existing price plus 1 per cent annual increase to compensate for inflation.

On the face of it this appears to be a genuine offer made by a fair minded service provider, particularly as the first contract was priced at roughly 75 per cent of the authority’s own costs. SDC’s management does not share this view. For one thing, claims are currently at least 25 per cent fewer than four years ago, but, more importantly, it has become apparent to a great many people that due to the use of DIP and other technology, the provider is using only 40 per cent of the staffing that SDC used. Consequently there is now a widespread view that the provider must be making a substantial and unacceptable profit from the arrangement.

SDC’s management feels uncomfortable and threatened by this situation. In recent times they have tentatively approached other service providers, but now doubt that any of them will come up with a substantially better deal than their existing provider is offering them.

Much of the internal criticism stems from the view that the service could now be done in house at a considerable saving on current outsourcing costs. Several internal mid-ranking managers have put forward the view that the DIP technology is no longer that special. They also argue that the provider appears to be staffing the system without any obvious technical back up. Nevertheless, senior management recognize that taking the service back in house will involve considerable risk for an organization that is short of the required technical expertise in most areas of activity. This is the basis on which the housing benefit function was included in the study.

When senior management study the project team’s findings they see a potential answer to their problem. There are several other business processes, both existing and potential, that could benefit from either the type of treatment the original provider gave to housing benefits, or from being associated with the housing benefit work. There is a temptation to offer this extra work to the existing provider but they decide against it. Instead, the management accept one of the cornerstones of BS – that to be sure that you have the best chance of becoming and remaining competitive the client must have a financial stake in the provider.

The overall logic of the SDC scheme is as follows. The internal IT department has never really performed at an acceptable level and there are real doubts that the authority will ever be able to attract people of sufficient quality to change this situation. Nevertheless, their own experience of outsourcing, their size and the problems that have been related to them by other authorities all point to the conclusion that they should shy away from any conventional outsourcing agreement. Consequently, they resolve to maintain the status quo as far as the IT department is concerned but to let it be known that they will shortly create a fledgling IT development company which they hope will one day take over all their own IT work and that of other organizations in the locality. They stress the local aspect of the concept by arguing that environmental needs will in future limit home to work commuting.

They hope to ensure the continued strength of the existing IT team by telling its members that they will have the opportunity to work alongside the new company on any work that is obtained privately and in due course, providing targets are met, there will be an option to transfer to the new company. A further ’carrot’ is created by the statement that individual equity in the new company will be open to existing IT department members for exceptional performance.

To make sure that the new venture will have every chance of success, SDC’s management believes that just one area of IT activity should be targeted in the first few years. Not surprisingly, they decide to concentrate on housing benefit work and the other related areas.

However, the level of current authority work in the areas under consideration is relatively low and they have no short-term way of knowing the potential for the satellite company to sell its services across the local business community. Without being able to quantify the short-term potential of the new venture, they prudently decide on a three-year development period before the satellite company takes full control of the targeted areas. Accordingly, they negotiate in advance with the current supplier of housing benefit services a new two-year deal for existing services only. This gives them a breathing space of almost three years to grow their own service provider.

In accordance with government guidelines, they contact all the other local authorities in the area and put the idea in some detail to each of them. Although some of these authorities initially show enthusiasm, it turns out, after six months of talks, that none of them has quite the same agenda as SDC.

Identifying joint venture partners

The next step is to begin a search in the local area for a small organization that would make a suitable joint venture (JV) partner. Initially their search was confined to small existing local IT companies, but after a number of initial discussions the SDC management decided to widen the target to include other small organizations with a growing IT development capability. Eventually they found one organization that looked suitable and where all the principals were excited about the potential outlined by SDC.

This is a three-partner firm of chartered accountants. One of the trainee accountants at this firm has developed his IT skills to a high level. The firm has benefited not only from his improvements to their own financial systems, but has gained considerable goodwill and fee income from contracting him and his small team out to clients. One area in which he has been particularly innovative has been in creating small but sophisticated networks. The trainee and his firm have had to pay a price for his success. His studies have suffered because he has spent an unusual amount of time on IT work. The shortage of study time problem is likely to get worse because he has recently married and his wife is now expecting a child. Just prior to SDC approaching his firm, the young man had informed the partners that as he was unlikely ever to qualify and become a partner, he was giving them as much notice as possible that he would soon look for a new position or start his own business. He indicated that he was ambitious and now believed that he had a future as a developer of IT systems. In return for being open about this he hoped that he might be considered for contract work in the future. As a growing number of competent and successful IT specialists are now working under the direction of the trainee accountant, the partners have much to lose.

Joint venture arrangements

Within a few months of finding this joint venture partner SDC had created a new small limited liability company with a start-up capital of £100,000. The ownership is split 80 per cent SDC and 20 per cent to the chartered accountancy firm. However, half of SDC’s holding (40 per cent of the total) will be transferred to certain key people who meet agreed targets within a two year timeframe.

Amongst these key people will be a marketing and sales manager recruited to begin the initial sales foray into the local marketplace, the IT specialist from the accounting firm and any other new employees who make a substantial contribution to profitable growth. The shares will be allocated in a way that both takes into account the perceived difficulty of the task set and their performance against target. Any shares not earned by performance will be retained by SDC. A maximum of 25 per cent of the total share value of the company will go to the new ventures people if they meet the targets set for them. In addition, SDC will use the other 15 per cent as a carrot for relevant authority employees who have demonstrated that they have added value to both the joint venture and the authority during the initial two years.

Benefits and drawbacks for SDC

The management at SDC will always have first refusal on the expertise and services to be developed by the new company. They believe that this will provide a very useful technology ’back up’ in a number of business areas. In particular they believe that by the end of the second outsourcing contract for housing benefit services, the new company will be able to provide a replacement service at a much reduced cost to the authority. Other benefits include the following.

Management will be seen as taking prudent steps to stop excess profits going out on a continuous basis to the current outsourcing service provider. It will be demonstrated that it is possible to work for a local authority and yet still benefit from the equity opportunities found in the market economy. The IT specialist and possibly others will still work for their original organizations for part of each month in the early stages. Consequently the new venture will not have to fund all their costs. With luck, the authority may have created a profit return that can in future be used to offset local taxes. The authority will have created a pilot scheme that can be repeated and improved upon for other business process areas.

Drawbacks will include the capital at risk, which will always need to be kept to the minimum, the time taken to get the project underway and the risk of failure.

Benefits and drawbacks for the chartered accountancy partnership

For this firm the benefits are as follows.

They get a reasonable stake in a new technology venture for a relatively small outlay. They dramatically improve their chances of keeping the services of their IT specialist on a part-time basis in the short to medium term. They would gain experience of an outsourcing/shared services environment. They might hope to build up a good working relationship with SDC which could in turn lead to other business opportunities.

The drawbacks will include the very small risk of losing their £20,000 of capital.

Benefits and drawbacks for the IT specialist and other employees of the new venture

Here the benefits would appear to include the following.

The opening up of new career opportunities without risking their current jobs or losing the advantages provided by their current jobs. The opportunity to get an equity stake in a potentially strong local company operating in a high technology environment without risking their own capital.

The drawbacks are difficult to identify. If the venture fails they will be in no worse a position and they will have gained valuable experience.