April 17, 2012Doug Hadden
Differences between public and private sector
Doug Hadden, VP Products
Large companies seek to improve spend management: the process of reducing costs through economies of scale. Aggregate multiple purchase requests for similar products to single tenders = lower prices. Performance management in the public sector has additional important characteristics. Why? Public sector procurement is more complex than the private sector. And, budget driven.
Government expenditures are controlled based on the budget. Budgets are the legal embodiment of government objectives and policy. The approved budget is often called the organic budget law or the budget vote. Government budgets should be credible. The planning – assumptions and expectations should be rational. And, expenditures should be controlled through commitment accounting methods to eliminate over and under spending.
Governments create programs to execute on objectives. One program consists of multiple procurement cycles. Therefore, procurement plans are aligned to the budget plan.
Budget preparation is a serious business in government. The assumptions about how many kilometers of roads or numbers of hospitals that can be built for a certain amount of money are critical. Government budgets, when fully spent for the purpose envisioned by the legislature and executive of a government, are expected to result in positive outcomes: Improved economic growth because of new roads. Improved health because of new hospitals. The expenditure is output based: X Kilometers of road connected with the input (budget). Outcomes are unlikely to be achieved if the outputs are based on incorrect assumptions. Poor assumptions means the government fails to build the length of roads envisioned in the budget. Or, poor control and performance management means that roads are not built because the budget was not fully executed.
Outcomes and outputs are the basis for government performance management.
Modern government budget preparation look at budget assumptions as cost drivers. A cost driver is an expected cost for a unit of something. A litre of petrol. A laptop computer. One hour of labour in road construction. These cost drivers can be packaged together to form an assumption for things like the cost of a training session (travel, lodging, per diem, course) or the creation of 1 KM of highway. Managers can see the predicted output of budgets. This improves decisions and makes the budget credible.
Procurement and Outputs
Cost drivers and packaging cost drivers are relatively easy in budget preparation. The difficulty comes in aligning outputs in expenditures. A cost driver or cost driver package may require multiple purchased items. A single procurement may include multiple output units and more than one package, especially if spend management is used.
It is critical to align the cost driver assumptions with reality. That way the budget spend and the outputs can be re-forecast during the year – rather than the surprise of finding that only ½ of the bridge was completed at the end of the project!
It’s difficult to align the “bill of materials” from multiple procurement cycles with the cost drivers. Not impossible. [Yet another advantage of the FreeBalance Accountability Suite.]
Government Performance Management during execution
Characteristics in which performance management in the public sector differs from the private sector include:
- Value for Money: Governments use value criteria to determine the cost per unit of outcome improvement. As John Glenn remarked: “As I hurtled through space, one thought kept crossing my mind: Every part of this capsule was supplied by the lowest bidder.” The lowest “compliant” price may not be the best value.
- Spend Management: The primary focus of government spend management is to create purchasing vehicles like standing offers with pre-negotiated bulk prices to facilitate the purchasing of commodity goods and to use e-procurement systems to get more competitive bids
- Output Progress: The progress for spending against the budget and the progress against project milestones need to be tracked.
- Transparency: Governments provide transparent public information throughout the budget and procurement processes.
Government procurement for complex projects like turnkey government financial management systems or airports tend to be more intricate that in the private sector. Consider that governments are involved in far more “lines of business” that the largest private sector multi-nationals. Many governments are involved in more government-owned businesses “lines of business” than large private sector conglomerates! Some complexity challenges in government include:
- Tender complexity: The procurement documents rendered to potential suppliers can run into the hundreds of pages. (And, the responses in thousands of pages. Military acquisitions often run into the tens or hundreds of thousands of pages.) Parts of proposals are often distributed among specialists for evaluation.
- Contract management complexity: Contract provisions and payment terms can be very complex for turnkey solutions. Milestone payments. Holdbacks. Performance contracts. And, complex contracts tend to operate for multiple years. This requires multiyear commitments in the government financial system. Missing performance criteria.
- Spend management in a cost-basis of accounting: It is relatively easy to identify arrears and the cost of these arrears when using accrual accounting. Government systems track transaction progress through commitments, obligations and goods received if running on a cash or modified cash basis of accounting.
- Macroeconomic changes: Changes in commodity prices (such as a major increase in food prices), natural disasters and other economic shocks have significant impact on revenue and expenditures. This affects costs meaning that outputs need to be re-forecast
- Vendor management: Vendor selection (qualifications, certifications, financial capabilities and past experiences), vendor performance management (timeliness, quality) and vendor blacklisting (corruption, poor performance, loss of certification) is more complex in government than the private sector.