Wednesday, 24 November 2010

Why Economies of Scale Can Lead to Higher Prices

Once again we have a government talking about saving money through shared services and combined procurement. It seems to make sense. If you buy 100, say, televisions you would expect to be able to negotiate a better price than if you only bought one. The same must be true for when the government buys services, mustn't it?

Actually the answer is often no. Let's look at my industry, training delivery. Parts of central government are now talking about combining all their training spend - for IT, management, health and safety and much more - across many departments. To bid you will have to be a truly massive company, the likes of Capita or Serco - and they certainly won't be as cheap as buying direct from a training provider. And control of quality will be fair more indirect.

For a government agency in, say Exeter, the best value training would probably be sourced from the local college or a small local provider. But neither of these will bid for a national contract. By making the contract so large, the competition is cut down to a small number of big companies who are rarely either best for value or best for quality.

Small Companies Can Provide Better Value and More Flexibility
One agency I know, after a full procurement some years ago, hired a one person company to provide their IT training. They provided the best value, most flexible, most responsive service I have come across anywhere outside of my company. (I know about it because Happy Computers was the back-up provider, for any courses he couldn't train.) But he certainly couldn't bid for any national contract and the large providers would have little reason to include him.

At the same time as going for larger procurement contracts, the government talks of including more small businesses - apparently unaware of the obvious contradiction. I've heard government representatives talk of how small businesses can be included as sub-contractors to the big bidders.

But this is a profoundly stupid approach. The benefit of contracting with small firms is better value and greater flexibility. You lose both by only contracting these companies as part of large contracts.

If the government goes ahead with its determination to centralise procurement you can expect some very complex legal contracts (yes, the one set of people who will definitely benefit are the lawyers), less direct contact with the providers and a far more bureaucratic approach. What you almost certainly won't get is lower cost.

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