The bottom line is the only thing that counts

Last month, Richard Gutch, the chief executive of Futurebuilders, urged voluntary organisations to stop talking about full cost recovery when bidding for services. Now Martin Narey, the chief executive of children's charity Barnardo's and formerly a senior civil servant in the Home Office, responds by saying the debate about commissioning is actually much simpler: it should all be about the bottom line.

Martin Narey
Martin Narey

As a commissioner of services, working in prisons and probation earlier in the decade, I was bemused by some voluntary sector organisations that, perhaps rather naively encouraged by government pronouncements, essentially slapped an overhead surcharge on contract costs.

What often happened next was that they first expressed horror when the additional cost was challenged and then shock when the previously contracted work was brought back in-house because the marginal additional cost of delivering the service directly had become less than the cost of contracting it out.

We in the voluntary sector can (and should) protest all we like about direct delivery costs that truly reflect public sector overheads, but we have to realise that hard-pressed public authorities will always, and understandably, be tempted by the additional cash costs of running services. Do you pay £1m to contract out a service for three years, or £950,000 to deliver it in-house and with investment in HR, financial and other overheads already paid for? There's no competition from a commissioner's point of view.

The full cost recovery issue has prompted an unnecessary diversion from what should be a much simpler debate. Contestability is about delivering services to the required quality at the lowest possible cost, and we should forget about the separate identification of overheads. Furthermore, we should certainly resist commissioners' attempts to delve into the cost structure of tender proposals to satisfy themselves about the reasonableness of organisational overheads. At home, I have recently had my garden wall replaced. In accepting a price from one of the three or four builders who tendered, I didn't check whether he spent rather too much of the bill on his office. What he did with the money, so long as we got the wall we needed, was of supreme indifference to me. Similarly, a commissioner needs a firm price for a job well done; nothing else should matter.

The full cost recovery promise might also, I fear, have led some voluntary organisations to loosen their grip a little on central costs. I need to reduce Barnardo's costs in this respect, but I know they are already more modest than those of many other organisations. Last year, although only six charities are bigger than us, there were - astonishingly - 33 that spent more than us on advertising. And the new HQ we are about to move into will, deliberately, be smaller and cheaper than our current offices and will still be, despite the inconvenience, at the far eastern end of the Central Line on the London Underground. We will continue to have a central London base, which I use every week, but it's a rather squalid, rather crowded and very cheap single room above a betting shop in Victoria.

Our parsimony is not simply because of the obvious need to demonstrate that we spend our voluntary income directly on children, but also because I know that in the future I will not worry simply about competition in running services from the excellent NCH and the Children's Society. I'll be fretting about the private sector, whose control of headquarters costs can be awesome. I know this because of my previously cited experience of commissioning work from private sector jail operators. If the voluntary sector does not at least maintain and probably reduce central costs, leaner private sector companies will be able to return a profit and still beat us on price - particularly when, as was the case with private prisons, their profits are not, as many imagine, 20 or 30 per cent but 10 per cent.

There will be no sentimentality from commissioners about the voluntary sector if the private sector demonstrates that it can deliver decent services more cheaply than us. And nor should there be. We do not have a monopoly on dedication or care. Those who choose to work for private sector organisations are not necessarily without compassion. Those who run them are not all profit-mad fiends. In the recent, very serious debate about secure training centres and the use of restraints on children, I was part-amused and part-angered by the way some voluntary sector colleagues referred to the centres being run by the private sector in the same tone of voice as if they were controlled by the Waffen SS.

There is no point comforting ourselves with the view that profit - however modest - is by definition in conflict with a commitment to providing decent services for the public. The uncomfortable reality is that as commissioners come under growing pressure to maintain the quality of commissioned services while controlling costs, the financial bottom line will be all that counts. Our sector needs to be quite certain that our significant advantage - in not having to return a profit of any magnitude - is not squandered.

Letters

The voluntary sector meets private equity

Richard Gutch wishes charities would behave more like businesses, with accompanying operating profits, loss leaders and market-driven price setting. If we proceed much further down this route, we might be only a couple of issues of Third Sector away from the news of the first takeover of a charity by a private equity fund.

Driving for profit may be an inevitable evolution for those charities heavily committed to service delivery under a statutory context, but it will surely be accompanied by a disintegration of their ability to fundraise. At that point, the sector as a whole will face a crisis of confidence as charities fall over themselves to persuade their donors of their status as 'true' voluntarily funded bodies.

The charities-as-businesses model lurches further into confusion with Gutch's claim that charities should leave their social values at the door to the negotiating room. This is at a time when most businesses are ploughing unprecedented resources into seeking to bring social values to their brand identities.

We are a not-for-profit sector - a fact we disregard at our peril - and not a consistently-at-a-loss sector, which is why core costs remain the best descriptor of our pricing structure. Is it perhaps less a case of the sector stopping talking about full cost recovery, and more a case of public service commissioners finally responding to the shift in the service providers' market as they seek to achieve best overall value for their customers?

Chris Askew, director of fundraising, Breakthrough Breast Cancer, London WC1

The crucial need to defend local grants

It was good to read Richard Gutch's assertion that grants for local groups are crucial to support voluntary action that will never generate income. Thank goodness the man in charge of promoting loans to the sector has this insight.

Navca is working with nine other national organisations to defend local grants. Too many local authorities and primary care trusts are rushing into procurement and competitive tendering when they should be sustaining their grants budgets.

Kevin Curley, chief executive, Navca, Sheffield

Ignore fixed costs and you will go bust

It takes a lot for me to put pen to paper in response to something I read, but I had to comment on Richard Gutch's article. His opening paragraphs are just not financially correct.

Of course, businesses look at all their costs when quoting for work. I can guarantee that the services company Serco, to use his example, builds in the chief executive's salary as well as the binmen's costs. It may not be so obvious as it is for charities, but it will be included somewhere. How does he think Serco makes a profit for its shareholders? It is a shame that he should start his article, which has some good points, with such a flagrantly wrong assertion, because it detracts from what he has to say and, I believe, gives the wrong impression.

Once an organisation is well established and has a steady flow of income and profits, and has covered its fixed costs, it can look at its margins and decide to reduce them to get additional work. But, and it is a big but, any organisation that works on only a marginal costs basis and ignores its fixed costs to calculate what it should charge, as he suggests, will end up bust.

Many charities do have the benefit over the commercial sector of being able to attract grants to fund their core or fixed costs. But what about those charities that are unable or find it difficult to obtain core grants, all for perfectly good reasons? What are they supposed to do? Ignore their core costs? It is simple, basic financial costing that you have to take into account all costs when looking at what charges you make.

Now the point missing form Gutch's article, and the question always asked in the commercial sector, is: are the profits or surpluses sufficient to do the work? In other words, is the contract worth doing? Why should the charity sector undertake work at marginal cost just to satisfy the Government? If the job is worth doing, pay for it properly - don't expect it to be subsidised by others.

If Gutch does not think that the restaurant bill is paying for the owner's mortgage, who does he think is paying for it? It certainly isn't the Government. I am sure he does understand financial costing, but it is not as simple as he makes out, and if you start out with a dodgy line, everything else will be tarred with the same brush. Perhaps this is the sort of thinking that leads to the Government getting so many funding issues wrong.

Nick Brooks, partner, Kingston Smith LLP, London EC1

Full cost recovery is the right way forward

I can sympathise with Richard Gutch's criticisms of full cost recovery, but he overlooks some important points. When commercial businesses tender for contracts, they don't look only at issues such as competitiveness and price (unless they are desperate).

First, they calculate their own costs using long-established methods such as break-even analysis and absorption costing, which is what full cost recovery is based on.

Businesses have to get their costs right or they go bust. Generally, non-profit bodies have not had to face that discipline. The Mini, an icon of the 60s, was sold for many years at less than the cost of production because British Leyland did not know how much it cost to make each car. Every car sold was subsidised by the unwitting taxpayer. We all know what happened to British Leyland.

Full cost recovery is at least an effort to bring the voluntary sector into the world of real accounting and cost analysis. I agree that asking for overheads may sound like a weak argument, but that just shows how much the procurement sector has to learn about costing, too. How many of the privatised local authority providers will be able to calculate their true costs?

If we don't promote a wider understanding of full cost recovery, we will see more contracts in the future that are undercosted, that underachieve and that could lead to more litigation for breach of contract.

Ian Morland, funding adviser, capacity-building team, Liverpool Charity and Voluntary Services, Liverpool.

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