The results business

1 July 2012 Payment by results is gathering plenty of traction at the top of government. Paul Jarvis looks at what the concept offers, and what it means for the future of infrastructure
“Payment by results is an unchallengeable theory,” says Hywel Madden, chief of staff at welfare-to-work provider, Ingeus UK. “Government payments should, where possible, be tied to the results being delivered.”

It’s hard to argue with that statement, which is perhaps why ‘payment by results’ has become such a popular buzzword in these times of austerity. From prisons to hospitals, to job centres and even schools, payment by results (PBR) is gaining traction as a model for the future.

In theory, it’s a win-win situation for the public sector and the private contractor, and as a result it could even go some way to rehabilitating the image of private investment in public services. “We see PBR as being something where we can demonstrate that we are delivering improved outcomes,” explains a spokesperson for services specialist and PBR practitioner, Serco.

But it will take time for progress to be made across the different sectors that it might be used in, with the private sector keen to know exactly what they are getting involved in. And that raises a significant question in closing the gap between theory and practice – are all the organisations that make use of the term doing so in a coherent manner?

Madden suggests not. “It’s a popular term, being used increasingly, and I’m not sure it’s always applicable to what the infrastructure industry might understand it to mean.” In health, for example, the NHS’s PBR initiative is designed to create greater competition between providers by paying them for each patient seen or treated.

But in the justice sector, the focus is not about bringing more prisoners through the doors. Rather, it is centred on transforming individuals to reduce reoffending, thereby cutting the cost of housing criminals at Her Majesty’s pleasure.

Those who have dismissed PBR as simply another version of PFI may have missed the point, because paying by results in fact implies a whole new mindset in terms of risk transfer and the contractual complexities to make schemes work.

“The public sector must remember it’s not buying widgets, it’s buying outcomes,” explains Stephen Hughes, partner at law firm Bevan Brittan. That is a fundamental difference for many who might have seen PFI as a way to build new infrastructure, with services thrown in to sweeten the deal and help make the financials stack up.

And the focus on outcomes, as opposed to outputs (the delivery of a new building), requires a change of approach from both public and private sectors. In particular, the private sector will need clear data on which to base any assumptions and calculations of future performance – something that the public sector is not always good at collating.

In prisons, for example, the justice department is undertaking pilots to come up with the best form of PBR contract that cuts reoffending. It is also focusing on PBR in its consultation on the reform of probation services.

Under the plans, contractors will take on a cohort of prisoners and only get paid after a period of time for each one that has left prison and not reoffended.

A source at one firm currently looking at that consultation says data collection – and properly understanding what results are being sought – will be key to any success.

“The issue is the data collection – how do you assess ‘reoffending’?” He points out that existing historical data can be skewed by changes in sentencing and policing policies. Trying to formulate any kind of business plan based on reoffending rates over the past decade or more would therefore be difficult. What might have seen a person cautioned in the past could see them sent back to prison today, immediately cutting the amount of money being paid to the contractor through a PBR contract.

“The contractor doesn’t have control over housing, access to healthcare, et cetera,” the source adds. “So you will have to work very closely with local authorities and other public bodies to deal with that.”

This is completely uncharted territory, making it difficult for contractors to put their full weight behind the concept because they do not have a robust data set to use to come up with realistic and financially viable business plans.

PBR at Work
Perhaps the genesis of the modern excitement around PBR lies in the government’s Work Programme, and the underlying ‘welfare to work’ concept that has been around in one form or another in the UK since the 1980s.

Under the Work Programme, an input payment of about 20% of the full value of the contract is given to the private sector for taking on an individual who has been out of work for a long period of time – usually more than 12 months. The private sector contractor, such as Ingeus, will then work with that individual for up to two years, receiving another payment when that person has been in work for three months.

Then there are payments every month after that for up to two years, to encourage the private contractor to ensure they are providing individuals with long-term employment, rather than simply getting paid for short work placements that have little impact on the overall benefits bill.

“The Work Programme is the culmination of 10 years of development on projects based on PBR to one degree or another,” says Madden. “The Work Programme has decent baseline data, so you have a more mature market and it is easier for the private sector to see how PBR might work in practice.”

Specifically because of the history surrounding the Work Programme and the welfare-to-work concept, there is a body of evidence that has enabled the government to put out a robust challenge to the private sector, and get a good response. “Private sector organisations have developed sophisticated models to anticipate operational and financial performance,” says Madden.

That’s not necessarily the case in other areas, and one source warns that the current plans in the justice sector focuses less on each individual, but more on a group of prisoners.

“There is a baseline reoffending risk and then they set a reduction target,” he explains. “That is a completely different risk profile.”

Risky business
It is, perhaps, ironic that at a time when PFI is being criticised for having transferred too much risk to the private sector unnecessarily, the big idea behind PBR would see even more risk passed from the public sector. But any attempt to make such a bold transfer of risk as under the Work Programme also needs the accurate data to back it up.

Indeed, there is a danger that the public sector, in attempting to achieve too much, will simply end up paying the private contractors the same for no improvements in service. “The private sector will take the risk if it feels it is a risk it can manage and control, so that they will definitely achieve the targets required,” warns one lawyer.

The Serco spokesperson is cautious here. “We have to understand the risks involved and understand the risks we are confident of delivering and put that proposal forward,” he says. It is then up to the public procurer to decide if that is an acceptable proposal, he points out.

The public sector must also be aware that transferring services to the private sector needs discipline to ensure savings are created. “The sting in the tail is that you pay for outcomes, not cashable savings,” warns Hughes. So in a prison, for example, if a reduction in reoffending is cancelled out by an increase in the number of new offenders being put away due to harsher sentencing policies, no savings will be achieved.

Similarly, in healthcare, the way to achieve savings in a PBR scheme might be to shut down a ward or hospital because patients are being treated quicker or in the community.

But such a move can be politically difficult. “But these cuts are coming anyway – so this is being done in conjunction with tough times for commissioners,” Hughes points out.

One option, however, might be to only introduce PBR as a small part of contracts to begin with, providing time for the relevant data to be collected over the years. “It is about striking the right balance between outcome payments, output payments and input payments,” says Madden. “There is a need to develop mechanisms that incentivise appropriate provider behaviours whilst setting an appropriate balance of risks that reflect both the maturity of the market and the quality of available performance data.”

There are already examples of PFI contracts which include this type of balance, as the Serco spokesperson points out. “In education, for example, we have contracts in Bradford and Walsall which are around a decade old, and even there part of those contracts were dependent on improving educational standards.”

What results?
For any PBR contract to work, though, a strong focus on the required outcomes – the results themselves – is critical. “Are you 100% results-focused, so that outcomes take priority, or are there sub-outcomes you want to achieve?” asks Madden.

In the Work Programme, for example, the government has had one eye on supporting small and medium-sized businesses in the supply chain. But because of the fact companies can only be paid once they have begun delivering results – people in employment – few small businesses have the capital up-front to fund that.

Similarly in education, a pure PBR structure is unlikely to deliver a satisfactory outcome for the government. If the ‘result’ required is a certain percentage of children achieving specific grades, the concern is that private contractors will simply sideline those that are not going to make those grades.

“For PBR to work, you need to be very clear about what results you are looking for,” says Madden. “If you introduce secondary outcomes, that can blur the issue and make it more difficult.”

While that is going to be more difficult for a school than a prison – where it might be argued it is easier from a political point of view to ignore some in favour of those more amenable to rehabilitation – they key question is whether the private sector will be interested in getting paid by their results.

At first sight, the answer, it seems, is ‘yes’. “As long as the framework is there, we would be happy to look at it from an investment point of view,” says Amey Ventures director Jay Doshi.  “As long as there is a long-term revenue stream coming in, we will actively look at it.”

“Contractors are generally bullish about payment by results,” adds Liz Jenkins, a partner at law firm Clyde and Co.

From an infrastructure viewpoint, however, PBR is still probably a step too far in most cases. Some believe there is potential for PBR contracts to include the funding of new buildings in years to come – and could even form part of strategic reorganisations based around reductions in, for example, the prison population or number of patients being admitted to hospital.

But that is still some way off, because funders are yet to get comfortable with the PBR idea. “Conceptually it makes sense,” admits Gershon Cohen, chief executive and fund principal of infrastructure funds at Lloyds.

“However, it will be a very difficult challenge to apply metrics on a lending proposition where there is no track record of prior performance.

“I get the theory but in practise I would imagine that it will require making assumptions about reoffending and employment [for example], which would have to be very optimistic to create a viable base case for lenders.”

“PBR remains new and relatively untested, and may be too big a step for capital-intensive programmes at the moment,” concludes Madden.

Only time and experience will change that, and it’s clear that the concept of payment by results is here to stay. “We are going to see more of PBR,” says Serco’s spokesperson. “It is fairly early days and it will take time before we have more detailed statistical outcomes from some of these areas.”

It will take time, but payment by results may yet prove to be the long-term heir to PFI after all.

This page was last updated on:
2 October 2012.

thumb

Banking bonanza

Multilateral infrastructure banks appear to be the new big thing

thumb

Give it a Year

There are a lot of personal and professional milestones for WSP director Gary McCarthy over the next few months. He talks to Amanda Nicholls

register

Register now to get un-restricted access to all sections of the website.

Want to see more first? Try our free preview...