Privatization And Outsourcing

Privatization And Outsourcing

Sara hoseini Ameneh moharerhaye esfahani

THE EVOVLING DEFINITIONS OF PRIVATIZATION • Privatization in its most traditional form referred solely to public sector divestiture of assets and service responsibilities, allowing the private sector to take over all aspect of service and service delivery. Time brings even more frequent examples that don’t fit the traditional model. [1] • “It is a tool for improving the economic activities through strengthening the market provided at least 50% of the estate shares are sold to the private sector” ( Bessly, 1983:1).[ 2] • “it includes methods which change the nature of relationships between public and private sectors, such denationalization, selling state properties, deregulation, contracting products and services”(Kay and Thomson, 1986:18)[2 ]

Privatization[1] • Current trends in the field of privatization denote not only widespread acceptance but a maturation as well. • The definition of privatization has became an indicator of evolution in techniques and practices. • It is no longer a partisan or ideological issue but a pragmatic and increasingly routine approach to governing and to managing public services.

A revised categorization for privatization[1]: • • • • • • • • • • • •

Asset sale or Long-term lease Contracting out ( out sourcing) Corporatization Franchise Internal markets Joint venture Management contracts Private infrastructure Public- private partnerships Self-help Volunteer vouchers

Asset Sale or Long -Term Lease • The government sells or enters into long-term leases for assets such as airport, gas utilities, or real estate to private firms, thus Physical capital Financial capital[1] In general the government has no role in financial soppurt, management , or oversight of a sold asset.[3] Two techniques for asset sale:[1] • Sale-leaseback: a government agency sells the asset to a private sector entity and then lease it back • Employee buyout: existing public managers and employee take the public unit private, typically purchasing the company through an Employee Stock Ownership Plan (ESOP).

Corporatization[1]: Government organizations are recognized along business lines. They are required to pay taxes, raise capital on the market and operate according to commercial principles. Government corporation focus on maximizing profits and achieving a favorable return on investment. They are freed from government procurement, pessonel and budget systems

Internal markets[1] •• ••

Departments areallowed allowedtoto purchase support services in-house Departments are purchase support services fromfrom in-house providerororoutside outside supplier. provider supplier. In-houseproviders providersofof support services required to operate In-house support services are are required to operate as anas an independentbusiness business unit competing against outside contractors for independent unit competing against outside contractors for each each department’s business. department’s business.

Market forces are brought to bear within an organization Internal customer can reject the offerings of internal service providers if they don’t like their quality or they cost too much

Public-private partnership & Self-Help[1] • Public-private partnership: The public sector works along with the private and nonprofit sectors and they can benefit from each sector’s special strengths, share risk, and minimize weakness.[1] • PPP’s can create linkages between different actors in the supply chain to integrate smallholders to overcome market failures at key chain bottlenecks. • Self-Help: Community groups and neighborhood organizations take over a service or government asset such as a local park. The new providers of service also directly benefit from the service. [1]

Joint Venture[1] • Government and private sector agencies from a joint board of directors to control asset management and service delivery and share responsibility for policy and management decision. • Asset maybe owned by government or by e new private firm. • Operation and service delivery may be contracted to the private partner or jointly provided.

Management contracts & Franchise[1] • The operation of a facility contracted out to a private company. (Facilities such as airport, wastewater plants, arenas, and convention centers.) • Franchise: A private firm is given an exclusive right to provide a service within a specified geographical area.

Private Infrastructure Development and Operation[1] • The private sector builds, finances, and operates public infrastructure such as roads, airports, recovering cost through user charges with several techniques: Build-Operate-transfer (BOT): The private sector design, finance, builds, and operates the facility over life of contract. At the end of this period, ownership reverts to the government. Build-Own-Operate (BOO):The Prive sector retains permanent ownership and operates the facility on contract.

Volunteers & Vouchers[1] • Volunteers: Volunteers are used to provide all or part of a government service. Volunteer activities are conducted through a government volunteer program or through a nonprofit organization. • Vouchers: Government pays for the services. These payment subsidize the consumer of the service , yet services are provided by the private sector. In addition to providing greater freedom of choice, voucher bring consumer pressure to bear, creating incentive for consumer to shop around service .for service providers to supply high-quality, low-cost services.

The reasons of privatization’s growth[1]: • Improve efficiency • Reduce the role of government • Allow private firms to perform commercial work that is not intrinsically governmental. • Expand the role of local, nongovernmental, and community-based organization. reduction in people’s dependence on government, thereby reducing public resistance to greater reliance on market mechanisms.

Summery of Before-and-after studies of contracting[1] Contracting agency

Number of contracts

Los Angeles county, 1979-1989

812

U.S. Department of Defense, 1978-1994

Cost before contracting

701

Saving (percent)

(millions $)

28

2,138

4,768

31

Wandsworth borough, London 1978-1987

23

174

27

State of western australia, 1993-1994

891

324

20

New opportunities[1] The major area to profit from privatization Are:

• government owned enterprises • infrastructure • social insurance . The three are radically different and, therefore, so are the ways that privatization is likely to evolve.

Examples of government owned enterprises[1] (in U.S.): • Export-Import Bank of the united states • Federal prison Industries • United states postal service • National railroad passenger corporation • Legal services corporation • Rural telephone bank • Corporation for public broadcasting

Examples of infrastructure[1] • • • •

Water supply Waste-Water treatment Transportation Prisons

Examples of social insurance[1]: • Social security:Retirement system • Social service: child care,job training, administering social programs under government contract. vouchers are emerging as the preferred privatization method for some social welfare services for two reason: 1-social services have been monopolistic, and vouchers introduce competition which destroys monopolies and improve services 2-It is difficult to specify quality standards in social services contracts, but vouchers offer a solution because standards do not have to be articulated.

Impact of Privatization and Managed Competition on Public Employees Employees fear: • • • • • •

Loss of jobs Reduced benefit Lower earning Uncertainity about future working conditions New policies Job requirement

Crucial issues in managing a privatization initiative[1]: • Communication • Employee involvement • Training Some public officials believe that the problems with government efficiency and performance do not lie with employees but rather with government structure and system

Decision making process toward a systematic approach Several pitfalls can occur without an established decision making process Accurate and complete cost data for public services are necessary for an effective competitive process. • Indiapolis and philadelphia have developed systematic approaches to evaluate both privatization and competition for services. – A commission in Indiapolis includes both public and private sector representative and analyzes costs, competitiveness, and performance evaluation. The Indianapolis model managed competition allows public employees to bid contracts – Philadelphia includes a 19-point checklist in its competitive contacting program that city employees use in evaluating contracting for service.

Decision making process :toward a systematic approach[1] Outside sources • Citizen and customer involvement for can help: -To build a political case for privatization -Shield against potential opposition -Ensure against a charge of favoritism or corruption in the privatization decision-making process

• Well-developed privatization or competitive initiatives involve many technical, financial, and legal issues that require expertise from variety of sources. They also demand citizen and employee input to help provide accurate information and encourage an open process.

Managed competition and employee transition[1] •

Evaluation: Involvement of employees in the decision making process can minimize the potential conflict over workforce changes such as privatization.

•

Opposition: Official encounter fewer obstacles to contracting initiatives overall but still face opporsition from employees.

• •

Emloyee programs Managed competition: Allowing government departments to compete with the private sector in the bidding process. These managed programs empower employees to structure bids Conduct cost comparisons Change the service delivery paradigm.

•

Growth in the use of employee strategies appears to be formalizing a role for employee at the policy level and making permanent changes in organizational structures and relationship and labor-management relations.

Monitoring and performance evaluation • Techniques: 1- monitoring citizen complaints 2-analyzing data and records 3-conducting field inspections 4-conducting citizen survey

It is wise for cities to use a variety of techniques. A single approach may not provide a proper overall picture of performance.

Case study1 [4] Port privatization efficiency and competitiveness

Introduction & theoretical consideration • Today, one of the most obvious phenomena in port industry is port privatization, since ports form a vital link in the overall trading chain and efficiency is an important factor for a nation to achieve internationally competitive advantages. • Based on the principal-agent theory, private ownership should be more efficient than the public one (Hartley et al., 1991;Parker, 1994).. • The transformation from public to private ownership, even without change in the competition, will be associated with improved efficiency (Hartley et al., 1991;Parker, 1994).

Results of past studies: subject

confirm

deny

Relation between port ownership structure and port operation efficiency

Liu(1995) Van Den Broeck et Coto-Millan et al.(2000) al.(1994) Braid(2000) Cullinane et al.(2002) Estache et al.(2002) Cullinane et al.(2002)

The effect of port size on port efficiency

Martinez-Budria et al.(1999) Notteboom et al.(2000) Cullinane et al.(2002)

Coto-Millan et al.(2000) Tongzon(2001)

Determinant of port comptetitiveness • • • • • • • •

Port (terminal) operation efficiency level Port cargo handling charge Reliability Port selection preferences of carriers and shippers The depth of the navigation channel Adaptability to the changing market environment Landside accessibility Product differentiation

Methodology: • This study uses stochastic Frontier production model of Battese and Coelli (1995) to investigate the relationship between port ownership structure, port size and technical efficiency. The technical inefficiency effects are specialized as a function of firm specefic variables, and the parameters of an inefficiency model are stimultaneously estimated with those of stochastic frontier production model.

Variables of Stochastic frontier model: • Variables: Yit :the production at the tth observation (t=1,2,…,N) for ith firm

xit Vit U it

: the logarithms of input variables : iid N (0, 2 )random errors, independently distributed of U it :non-negative random variables, denoting technical inefficiency of production

Yit = exp( xit

+ Vit

U it )

Stochastic frontier model: • The second equation is the regression of the inefficiency effect, U it on the variables that explain this inefficiency. z it : a (1 × M) vector of obsevarble explantory variables : a ( M ×1) vector of unknown scalar parameters to be estimated W : is defined by truncation of the nominal distriutio n with zero mean and variance it

U

it

=z

it

+W it

2

Stochastic frontier model: • The method of maximum likelihood is proposed for simultaneous estimation of parameters of the stochastic frontier model and the parameters technical inefficiency effects model.

TE it = y it exp( x it

+ v it ) = exp( x it

exp( u it ) = exp( z it PCI i =

+ v it

u it ) exp( x it

W it )

W K X ik

PCI i : port competitiv eness index of the ith port Wk

: the weight of kth indicator

X ik : unit free valueof the kth indicator for the ith port.

+ v it ) =

Stochastic frontier model: • Then the above port competitiveness index is used to justify the use of total throughput as a proxy for port competitiveness and run a linear regression of the total throughput on the determinants of port competitiveness :

PC i = f ( X ik , ) PC i : represent the total throughpu t of port i. The determinants of port competitiveness are entered in the model as the independent variable. The coefficient on these independent variables represent the effect of determinants on the port competitiveness.

• The estimates are based on the maximum likelihood method relying on the FRONTIER package, version 4.1. The stochastic frontier production function to be tested is;

variables

• The test on functional forms can be carried out by the generalized likelihood-ratio method, which works as follows:

LR = 2{Ln[L( H 0 )] Ln[L( H 1 )]}

Where L(H ) and L( H ) are the value of the likelihood function under the null hypothesis (H0 = 4 = 5 = 6 = 7 = 8 = 9 =0) and the alternative (.H ) 0

1

1

In this case if

H

0

:

2

(

2

+

2 p

)

= 0

is true, the generalized

likelihood –ratio stochastic, LR, has asymptotic distribution which is a mixture of chi-square distributions.

• The model for the investigation on port competitiveness are as follows:

PCIi =W1 Xi1 +W2 Xi 2 +W3 Xi3 +W4 Xi4 + W5 Xi5 + W6 Xi6 + W7 Xi7 +W8 Xi8 PCi =

0

+ 1 Xi1 + 2 Xi 2 + 3 Xi3 + 4 Xi 4 + 5 Xi5 + 6 Xi6 + 7 Xi7 + 8 Xi8 +

i

-0.639 :Ports with larger size are more efficient than port with smaller ones. -0.666: Positive relationship between technical efficiency and privatization in port industry +0.415 : An inverted U-shape relationship between technical efficiency and privatization

Burchardkai(German)

Felixstow (UK) PSA(singapore)

PRIN1=0.53 EFF+0.25 DEP+0.52 NDC+0.58 LAN+0.24 ADA

Efficiency port selection preferences of carriers and shippers lanside accessiblity

Conclusions: 1- Private sector participation in the port industry is useful for improving port operation efficiency. 2-This study shows that the best extent of private participation in container ports/terminal is between the private public and the private mode. 3- It is better for port authorities to limit the private sector participation within the “landowner and operator” function and take over the regulatory function. 4-port authorities should introduce private finance, operational & management instead of state funds and administration while they remain in place as regulators. 5-implying partial privatization is as a quite effective way to help port authorities to win in the competition. 6-Another most important factor is adaptability to the customer’s demand.

Case study2 [5]

Institutional and structure changes in air navigation service-providing organizations

Major changes in ways in which ANSs are provided: • • • •

Single Europe skies Financial factors Technology Ownership and economic regulation

The air transportation value chain • ATC is one element in a longer value chain that ultimately provides air transpotation services to customers. • One reason to recent pressures to review the nature of ANSs is that many airlines markets have been found to be financially unstable, whereas the overall air transportation industry, including navigation services has enjoyed relatively high returns.

the underlying problem with the airlines is their inability to recover the fixed costs of providing scheduled services in what are now often competitive markets.

Supply models and ownership •

The ownership really did not matter when it came to efficiency (AngloSaxon 1970) -It is the market structure within which suppliers operate that is the determinant of behavior. -Public ownership may be desirable when there are public good elements in supply and other alternatives, such as subsidies, are difficult , for reason leakage and transaction costs, to apply (but in these cases it was a matter of practical expediency rather than a firm criteria) -in other instances, where there are serious externalities, that cannot, for technical reasons, by easily internalized by properties right allocation, again public ownership can be justified. -when the output is a merit good again there may be a rational for public ownership.

But in these cases, once provided is not ownership per se that determines efficiency but rather the incentive structures that influence the behavior of management.

Privatization and some related matters: • “ownership deosn’t matter”. • new forms of regulation, most notably price capping • Outsourcing • “For” market & “In” market • Commercialization • Flexiblity of privatization in investment financing

Commercialization? • In practic, commercialization includes: 1- the creation of public-private partnerships 2-corporations 3- not-for-profit corporations 4- the use of user charges 5-access to private financial markets, 6-tendering-out services (commercialization doesn’t not, however, always mean privatization in its full sense; it can entail changing the ways in which a government-owned enterprise is financed, regulated, and managed.)

Variants available of the formation of public/private partnership with both parties having a share in the ownership of the enterprise

What did the table say? • There has been a demonstrable shift away from state ownership but with a variety of institutional structures emerging. • The different approach to corporatization can be seen to reflect wider national attitudes to the topic with some countries having a tradition of preferring particular types of corporate entities and experiences of there workings.

Rate regulation • Rate-of- return: rate of return conditions-notably non-profitabilitybuilt into the terms under which the corporation is established. (US industrial policy, Canada, Netherlands, South Africa, and Switzerland) • Price capping: the setting of maximum average price across a bundle of output that is related to changes in general price levels, was initially developed in the UK by Littlechild (1983) for the privatized telecommunications sector. It was advocated because of its low informational needs and it is directly aimed at minimizing X-inefficiency, both static and dynamic. • Commission: some countries have commissions that monitor the rates that are levied; the ministry fulfills this role in a number of cases.(Canada, Australia, South Africa,..) (X-inefficiency: arises largely because of the ability of the regulated agency to capture the system and to enjoy significant inert areas without the pressure of full cost efficiency)

How was done assessment? • The quantitative assessment with trend analysis • Using trend assessment for the dynamic response of a ANSP • The time frame= 8 years • Economic regulatory analysis form, examines the ties between the structure of an organization and it economic performance through the way it conducts itself in the market.

Fig .Annual capital exepditures of larger ANSPs (in 2004 prices)

• •

“ Commercialization has allowed the ANSPs to implement modernization projects more effectively” Any discernable pattern for smaller ANSPs because their investment tend to be discrete and irregular.

FAA

2004

38%

2004

24%

1997

Other five (average)

1997

What the data don’t show… • The nature of the investment • Commercialization and access to private finance market pushes their organizations towoard the maximum production possibility frontier but there are clear problemsof self-interest involved in these insight. • Investment program are dependent on the capital base. • Effect of event such as 11 September 2001. • Government guarantees help, but moral hazard problems abound. Airservice Australia NATS UK NAV Canada

$ 70 million in standby/money market facilities $4 million in overdraft arrangement $ 38.6 million liquidity reserve $4 million debt-service reserve for 6 month $ 170 million operation and maitenance reserve $ 125 million debt-service reserve $520 million as unallocated credit facility balance

Labors: Air traffic controllers • 60-70% of a typical ANSPs’ operation cost are labor costs and ANSPs heavily reliant on their air traffic controllers. • Increase strikes and other form of disruption • NAV Canada employees have received higher wage than their counterparts in the public sectors.(37%>22%)

Staff savings Airservic e Australia

4000

2000 Airways NZ

1100

After commercializati on 700

FAA & NATS UK& NAV Canada Switzerland Sout Africa

With reduction in the number of control areas from 5 to 2 Adopting new technology

An increase

Qualitative considerations: • The Interaction with customer (“good will”) This can be important for minimizing the economic transactions costs of delivering a service. • In many cases there requirements for consultation with customer concerning service charges (South Africa, NAV Canada). • NATS UK has developed an operational partnership agreement with customer to share knowledge on sector growth and delays; this has had some successes including major reductions in delays at Manchester airport through implementation of new procedures.

Air navigation and military under commercialization • Most of countries that were studied in this case, had separate departments and controllers but they had agreements with ANSPs about services and exchanging data and information.

Delays: • Delays are very costly to airlines and their passengers and freight customer. • The FAA is the main exeption, where delays were rising before the attack on the US and began to rise again relatively soon after the event. • Predictability of delays is as important as the amount of delay.

Safety: • Major incidents are extremely rare in air transportation and hence there is a tedency to make use of proxies. • The airprox trends indicate a general decrease in serious potential safety incidents for some commercially driven ANSPs in UK, Canada but an increase in others

Consolidation as a way to cost reduction: country UK: New Zealand:

saving $13 (2002-2003)

With consolidation two operations into new Swanwick Center

?

Has consolidated four radar centers into two

Transition Project

Privatization/Contracting PROGRESS • Improvements Have Been Made to the Legislative Framework Governing Procurement, Acquisition, Contracting and Outsourcing Processes • Increased Simplification of Procurement and Contracting Processes and Expanded Use of Business-Oriented Acquisition Models and Information Technology • Expansion of Performance-Based Contracting and Other ResultsOriented Procurement Vehicles • Agency Efforts to Pro-Actively Manage Contract Disputes Have Led to a Substantial Decrease in the Number of formal Bid Protest Cases Taken to the GAO • Where Applied Effectively, the A-76 Process has Stimulated Government to be More Competitive and Strategically Rethink its Processes

Transition Project

Privatization/Contracting CHALLENGES • Additional Efforts are Needed Within Each Agency to Simplify and Streamline Procurement and Contracting in Government • Agencies Continue to Struggle to Implement Performance-based Contracting and Effective Contract Monitoring Systems • Implementation of A-76 is Uneven Across Government, With The Process Not Used Effectively by Most Agencies • The Quality of Cost Data and Financial Information used in the Procurement and Outsourcing Processes Needs to Improve • Significant Problems Surround the Implementation of the Federal Activities Inventory Reform (FAIR) Act • Greater Efforts are Needed to Involve and Protect Federal Employees During the Outsourcing Process

Transition Project

Privatization/Contracting CHALLENGES • Tension Between Program Staff and Contract Staff Exists, with a Need for Greater Collaboration between the Two Communities on Improving the Procurement and Contracting Processes • Some Contract Officers and Program Managers Lack the Skills That will be Needed as Government Increasingly Turns Towards Contracted Services and Outsourcing

Transition Project

Privatization/Contracting RECOMMENDATIONS • #1 Develop an Aggressive Champion to Lead Efforts to Improve Contracting, Procurement and Outsourcing in the Federal Government • #2 Aggressively Implement Performance-based Contracting and Provide Incentives to Contractors for Improved Results • #3 Launch a Process to Re-Engineer the A-76 Process Government-Wide • #4 Continue the Trend Towards Simplification, Flexibility and Streamlining in Government Procurement • #5 Develop Specific Proposals to Remedy the Shortcomings Identified in the A-76 Process

Transition Project

Privatization/Contracting RECOMMENDATIONS • #6 Examine Alternatives to the A-76 Process • #7 Invest in Training Federal Contract Officers and Line Managers for Managing Government Programs in a Highly Contracted and Outsourced Environment • #8 Fully Implement the FAIR Act, Emphasizing Its Use as a Tool for Creating a Data Base Rather than Merely a Privatization Vehicle • #9 Collaborate with Employees and their Unions During Outsourcing Initiatives and Develop Pension and Benefit Portability Solutions

Opportunities for partnership exist Partnerships can improve access to – – – – –

New technologies, and tools New research expertise and infrastructure Private equity markets; donor funding New product markets and new customers New marketing and distribution networks

Synergies through knowledge sharing, joint learning, scale economies, resource pooling, and cost sharing

The role of partnerships in supply-chain management • The Policy Dialogue highlighted the roles that partnerships can play in maximizing the efficiency and effectiveness of sustainable development orientated supply-chain management strategies. Examples discussed at the dialogue included: – • Partnerships between groups of companies working with the same suppliers, enabling partners to develop common standards and share the costs of monitoring and verification (e.g. the work done by the Hudson Bay Company with other department store chains internationally). – • Partnerships which build private sector capacity in developing countries, enabling companies to start sourcing products and services from local suppliers, thereby increasing their economic contribution to host countries and reducing operating costs (e.g. the work done by Chevron Texaco and UNDP in Kazakhstan and Angola).

Institutional Design Regional Specific Context

PRINCIPAL

Techno-economic Characteristics Constraints • Information • Transaction • Administrative and political

AGENT

Performance of institutions Efficiency Equity Imputability Economic Development (regional)

Options Public Monopoly

Public-corporate management

Delegated Mgt.

Concession

Privatization

+ Private

Extension

PPP

+

Smallholder

Thus, PPP’s must intervene at multiple chainlevel bottlenecks; targeting one may not benefit the whole supply chain

+

+ +

PPP

Private

Public

+ Processor

+

PPP’s must also induce positive chain effects. PPP’s must create positive effects for processors, retailers, etc., that have positive feedback and benefit the whole supply chain.

Retailer

+

+

Chain level

• Designing contracts for publicpublic-private partnerships: partnerships: • Different clauses different compensation – – – –

liability & control sharing risk management and sharing cost sharing conflict resolution

Designing contracts for public-private partneship: Risk management (integrated) * Choosing a risk-return combination risk risk management ressource management return * Sharing risk - risk aversion / tolerance - risk pricing

Designing contracts for public-private partnerships: Liability and control / Information strict liability strict, joint and several liability extended liability capital structure limited liability incentives for care and diligence

Delegated Management and Cost Sharing Multiple public - one private partnerships •Principles

- fairness / equity - coherence - efficiency - cross-subsidies

•The Shapley-Shubik approach (incremental costs) •The sequential cost sharing approach (heterogenous needs and demands)

Designing contracts for public-private partnership: Conflict resolution

• Inserting the process in the contract • Exchanging information / arguments • Third party arbitrage • Residual rights owner - value and pricing

Role of the public partner (municipal) •Core competencies - identifying public needs (broker of citizens interests) - arbitrage between needs - managing contracts for maximal social value creation •Time horizon and incentives

The role of the private partner • Core competencies

- technology use and development - economies of scale and scope - development and export of know-how (human capital) • Reputation building: Dynamic incentives and opportunism

Case Study3: Retail Supply Chains in Thailand[ • Key issues in supply chain: Retailer TOPS unable to ensure quality control and traceability in purchases and handling, poor logistics, faced numerous intermediaries. • Main market failures: information asymmetries, high transactions costs, poor organization. • Supply chain efficiency improved through creation of a centralized distribution center, private sector partnerships, and a series of PPP’s targeted at specific parts of the supply chain

Case Study: Retail Supply Chains in Thailand • Partnerships developed by TOPS (Private-only and PPP’s): – Syngenta: input distribution and training – TNT: improvement of logistics – SGS-Dept. of Ag. (PPP): product certification program – Dutch research institutes-Thai Universities (PPP): market analysis, research, training

Case Study: Retail Supply Chains in Thailand • Effects on the supply chain were quite positive: logistics were streamlined, certification and traceability initiated, postharvest losses reduced • Market failures on information and transactions costs reduced. • Smallholders were not the target of these PPPs (number of suppliers reduced from 250 to 60). The chain benefited, but not through direct interventions to small farmers. • Market failures regarding organization of smallholders needed to be developed to include them in HVA supply chains.

Retail Supply Chains in Thailand Traditional Channel Farmers

Input Suppliers

Transporters

Wholesalers

Brokers

Market Failure: Transactions Costs with Multiple Suppliers

Distribution Centers

New Channel with PPP’s Private Sector: Input Provision to Farmers

Input Supplier

PPP: Certification of Farmers

Farmers

PPP: Market Research

Private Sector: Improve Logistics Supermarkets

Wholesaler

Distribution Center

Supermarket

Market Failure: Poor Coordination of Quality Information (Chain-wide)

Customers

Customers

Private Sector: Establish Distribution Center

What is outsourcing?

Outsourcing is defined as the contracting of one or more of a company’s business processes to an outside service provider to help increase value, by primarily reducing operating cost and focusing on core competencies. CIO defines outsourcing as arrangement in which one company provides services for another company that also could be or usually have been provided in-house.

What Are Outsourcing and Privatization? Economist Calvin A. Kent explains with a still timely definition in Entrepreneurship and the Privatizing of Government(1987) that privatization “refers to the transfer of functions previously performed exclusively by government, usually at zero or below full-cost prices, to the private sector at prices that clear the market and reflect the full costs of production.” Outsourcing, according to Coopers & Lybrand’s Breakpoint: Business Process Redesign, (1992) is “the practice of contracting out for services once run by an organization’s employees and managers.”

Types of Outsourcing • There are two types of outsourcing activities. One involves entrusting external firms with the company's comparatively less important activities, in order to concentrate resources on core competencies. The second is the reliance on an external firm to handle some tasks when the company is facing difficulties in achieving core competencies by itself. As shown in Table 1 , these two types can be thought of as the outsourcing of core competencies and the outsourcing of functions other than core competencies, like cost reduction efforts, and the establishment of subsidiaries and networks.

Why do companies outsource? • Alleviate administrative burdens and focus on strategic areas. • Change of the profile of the time spent by the executives on various activities. Strategic

10%

Admin.

Tactical

30%

Tactical

Admin. Without Outsourcing

60%

Strategic With Outsourcing

• • • • • • • •

Reduce costs Focus on core function Acquire new skills Acquire better management Assist a fast growth situation Avoid labour problems Focus on strategy Avoid major investments

• • • • • • • •

Handle overflow situations Improve flexibility Improve ratios Jump on to the bandwagon Enhance credibility Maintain old functions Improve performance Begin a strategic initiative

Outsourcing: Types of Relationships • Traditional (commodity-for-cash transaction) • Teaming partners (project oriented - e.g., ERP implementation) • Long-term alliance (multi-year service) • Networked companies (pool efforts to achieve common goals)

Outsourcing Risks • These can range from pricing issues to nonperformance by a supplier of a key functions. The person making the outsourcing decision must be aware of risks before making the decision to hand over a function to a supplier. • These risks can be classified into short-term and long-terms risks. Short-term risks can include among others operational issues at supplier’s end, while long-term risks can be nonalignment of company’s goals with supplier’s goals in the long term. • Supplier’s situation may change in the future, causing problems in the outsourcing relationship such as supplier’s financial difficulties or change of needed technology. • Supplier’s inability to grow in the same proportion as the company, can be another big risk.

Outsourcing Process • • • • • • • •

Understanding company goals and objectives A strategic vision and plan Selecting the right vendor Management of the relationships A properly structured contract Open communication Senior executive support Use of outside expertise

Outsourcing In SCM • Outsourcing logistics has been a favorites with companies since several years. It is only recently that companies have started thinking about outsourcing other aspects of SCM. • Lean companies are new opportunities in SCM outsourcing. This new avatar can ensure a faster response, agility and better ability to handle pressure: In this case, outsourcing SCM can ensure that the entire necessary infrastructure is in place, without actually having to spend on any infrastructure. This can save a lot of working capital from getting locked. Companies can focus on core activity of getting the customers and servicing them efficiently. Enterprises can avoid all or some of the costs associated with physical plant, specialized IT systems-and best of all- no distractions from the carrying out of their core competencies.

Seven Myths of Supply Chain Outsourcing • My outsourced partners are all supply chain experts. • My partners have state-of-the-art information technology infrastructure. • By outsourcing production and fulfillment, I will not have to worry about execution. • My outsourced partners will provide expert project management. • Outsourcing automatically gives a time-to-market advantage. • Outsourcing is the key to making my operations highly scalable. • Fulfillment is easier to outsource than manufacturing.

EXAMPLES OF SUCCESSFUL OUTSOURCING • Information Technology (IT) outsourcing; • Software Development; • Software Support; • Business Process Outsourcing (BPO); Customer Support Outsourcing • Accounting; • Human resources; • Benefits: • Payroll; • Finance functions and activities;

• Marketing; • Knowledge Process outsourcing (KPO) • Legal Services Outsourcing; • Legal Documentation Outsourcing • Paralegal Outsourcing; • Engineering Services Outsourcing • Mechanical Drawings • Conversion Services - 3d Models • Architectural Drafting

Outsourcing: Criticisms • Inability to improve on cost / time in new application development • Inability to quantify/measure value-added • Risks of losing core IT infrastructure (what happens if we decide to move in-house) • Cultural barriers in mixing vendor with customer personnel • Vendor’s lack of customer’s business knowledge

Some of the most significant factors of Outsourcing FIASCOS

• • • • • •

When companies start to consider the setting up of an outsourcing strategy they often run into a string of problems, they either failed to consider such as: The Changeover Need for effective understanding of core competencies Need to manage Complexity What’s at the core Measurement

Drafting an outsourcing contract 1.

2. 3. 4. 5. 6. 7. 8.

Start all contracts with the companies’ business objectives. Why is this process being outsourced? What are the components of the process to be outsourced? Determine and align clear business objectives with the supplier’s capabilities. Employ internal and external benchmarking to determine current capabilities and costs. Develop performance and cost targets to develop initiative. Create and build initiative-based targets into the contract. Fulfill the initiatives. Review performance regularly and mete out rewards or penalties to the supplier. Decide whether to expand or shrink the relationship with the outsourcer.

How to Draft an Outsourcing Agreement, BPO Agreement, KPO Agreement ? • A good outsourcing agreement is one which provides a comprehensive road map of the duties and obligations of both the parties - outsourcer and service provider. It minimizes complications when a dispute arise. However, many a times people neglect to pay attention while drafting an outsourcing agreement. • Success in outsourcing can be expected when Outsourcing Agreements, Service Level Agreements & Contracts are set up right and the parties know their duties well. • Before finalizing an outsourcing agreement, the terms should be thoroughly discussed and negotiated to avoid any misunderstanding at a later stage. Lawyers from all applicable jurisdictions must be consulted before finalizing any outsourcing agreement.

Before signing an Outsourcing Agreement the following must be properly addressed • Duties and obligations of Outsourcer • Duties and obligations of service provider • Applicable law to outsourcing agreement • Term of the Agreement • Events of Defaults and Addressing • Dispute Resolution Mechanism them • Time limits

• Location of Arbitration • Number of Arbitrators • Interim measures/Provisional Remedies • Privacy Agreement • Non-compete Agreement • Confidentiality Agreement • Rules Applicable • Appeal & Enforcement • Be aware of local peculiarities • Survival after Termination of the main agreement.

Outsourcing, Contracting, Privatizing and Partnering… WON’T WORK… unless we focus on one key issue…PERFORMANCE Successful outsourcing projects had the following motivators: • Flexibility and speed • • • • •

Cost containment/certainty Improved quality Access to personnel or skills Innovation Enhancing focus on core mission

What makes a contract “PerformanceBased?” • Soliciting bids on the basis of what RESULTS you want achieved rather than what ACTIVITIES you want conducted • Defining clear performance expectations and measures (baseline vs. expected results) • Clearly defines due dates and milestones • Providing incentives for performance • Granting flexibility in exchange for accountability for results • Monitored to ensure performance is being achieved

Critical Success Factors for Managing a Performance-Based Contract • Monitor Performance with regular reporting • Adjust! Adjust! Adjust! – Identify changes in external factors that will impact performance – Devise corrective action plans for deviations – Benchmark and compare! Analyze for next steps! – Revise performance targets to continue the push for gains • Provide comparative performance data to contractors: create a “race to the top” culture • Communicate and reward success!

Agency Strategy and Outsourcing Other Government Agencies Devolution Mission Outcome Goals Strategy Program Alignment

Information Technology

Deregulation, in favor of partnerships with industry Performance-based Contracting

Budget Alignment

Privatization

The Results Act

Partnerships with religious/civic institutions

case study 4: Bank Privatization in Argentina : A model of political constraints and differential outcomes

George R. G. Clarke, Robert Cull Journal of Development Economics 78 (2005) 133– 155

• This paper presents a simple model of the tradeoffs governments and buyers face during these transactions. In addition to price, the buyer is concerned about solvency and profitability following privatization. • Similarly, politicians are concerned about layoffs and service coverage. • They apply the framework to provincial bank privatizations in Argentina, finding that provinces with fiscal problems were willing to accept more layoffs and guarantee more of the privatized bank’s portfolio in return for a higher price.

• They study the provincial bank privatizations of the 1990s in Argentina, an episode that resolves many of these problems. Privatization decisions were made by the provincial governments, providing them with variation along several important dimensions, including fiscal performance of the province, bank performance and the political incentives facing important players, while keeping other institutional details similar. • This is the first attempt to theoretically model how political incentives affect the features of bank privatization contracts and to test whether the outcomes adhere to the model’s predictions.

Provincial Banking In Argentina • At the beginning of the 1990s, all Argentine provinces owned at least one bank. • The publicly owned provincial banks performed poorly in terms of portfolio quality, the efficiency with which they generated income, and their return on assets. • The provincial governments could borrow from the public provincial banks, which would then discount the loans to the Central Bank of Argentina.6 Further, if the provincial banks found themselves insolvent, they could rely upon the Central Bank to bail them out. • This meant that provincial governments had little incentive to monitor management closely and could use the banks to finance favored programs at relatively low cost.

• This arrangement ended in the early 1990s, when the newly elected Menem administration implemented the Convertibility Plan. The main pillar of the Convertibility Plan was the April 1991 Convertibility Law, which pegged the new Argentine peso to the U.S. dollar and forced the Central Bank to restrict the monetary base to the dollar value of international reserves. • The Convertibility Law, and the new 1992 Charter of the Central Bank that supported it, profoundly affected the provincial banks, by preventing the Central Bank from rediscounting loans and from guaranteeing bank deposits. • The Tequila Crisis hit Argentina in December 1994, accelerated privatization decisions further by imposing substantial fiscal costs upon the provinces and aggravating solvency problems at the poorly performing provincial banks.

• Taking advantage of the external shock, the Federal Government, with the assistance of the World Bank and the Inter-American Development Bank, created the Fondo Fiduciario to further encourage privatization. This federal agency extended loans to the provinces to help them privatize their provincial banks. • Under the Fondo Fiduciario program, the provinces split the public provincial banks into two parts—a healthy bank to be privatized an a residual entity containing non-viable assets. • the basic strategy was to shift the most attractive assets to the privatized bank and then to match those assets with liabilities up to the point that the privatized bank’s net worth met Argentina’s prudential standards. The provinces used the loans from the Fondo Fiduciario converting short-term obligations to long-term loans. • With this new incentive, and an uncertain liability hanging over their heads, many additional provinces decided to privatize. By the end of 1997, almost half of the twenty seven provincial banks had been privatized and several other privatizations had been authorized but not completed.

Provincial bank privatization contracts • In the Argentine, two important opponents to privatization – bank employees and residents of underserved (mainly rural) areas – were bought off through agreements to limit layoffs and requirements that the banks maintain service. • To pass a substantial share of low-quality assets onto a private purchaser while imposing branching and labor restrictions would have been difficult, if not impossible, without concessions on other dimensions. The most attractive of these were the service contracts that were awarded to purchasers to provide banking services to the provinces and guarantees as to the quality of the acquired assets. In interviews, the new private owners confirmed that these contracts are of vital importance, as an abnormally high share of the privatized banks’ income is generated from services. • Rather than verify the quality of individual assets, which would have been time-intensive, many provinces guaranteed a substantial share of the assets transferred to the privatized bank.

• In particular, many of the contracts restricted the new owners’ ability to lay surplus workers off and close unprofitable branches. • However, to entice buyers, the provincial governments were willing to sweeten the terms of privatization by assuming responsibility for low-quality assets through the residual entities, guaranteeing assets allocated to the privatized bank, and providing the new owners with service contracts.

A Simple Model Of Bank Privatization • Conceptual framework: Our basic premise is that political and economic constraints dictate the timing and design of bank privatizations. This will help us understand the second link in the framework—how political and economic constraints affect features of the privatizations including privatization contracts.

Theoretical model • The theoretical model below summarizes the tradeoffs faced by two agents, a government and a potential buyer, in the sale of an insolvent state-owned bank. • The purchaser is concerned about the probability that the privatized bank will remain solvent, the profits earned if the bank does so, and the price paid for the assets and liabilities it assumes. They denote the probability of solvency f(xr), which we assume is bounded between zero and one and weakly decreasing in xr (i.e., as the purchaser assumes more risky assets, the probability of insolvency increases).

Parameters and decision variables • We denote the probability of solvency f(xr),

• We denote income on the assets assumed by the purchaser h(xr) and we denote the cost of managing the portfolio as c(xr).

• Patronage jobs are denoted wL where w is the wage paid to employees and L is the number of employees. The buyer’s payoff from purchasing the privatized bank will be:

• where s ~[0. . .1] is the purchaser’s ownership share and Pb is a lumpsum payment paid to the government.

• We assume that the purchaser must receive its reservation profit level, p[ , to take control of the bank. That is:

• The government derives fiscal benefits from three sources. First, it will earn a share of the privatized bank’s profits from its retained ownership in the bank.

• It will also receive the lump-sum payment for the bank:

• Finally it will receive some revenue from recovery of residual assets, denoted g(xres), where xres is the quantity of assets in the residual entity managed by the government and it will expend some recourses to recover these assets, cres(xres).

•

We assume that the total value of assets recovered is increasing as additional assets are passed to the private buyer.

• •

Where x\pub denotes the total assets of the public bank prior to privatization. The final component of the government’s optimization function is the benefits it receives from patronage jobs at the privatized bank, which we denote k(L).

•

We assume that the government chooses xres and L to maximize the following:

•

KL and KM are components that map the benefits that the government receive for protecting jobs and the fiscal benefits related to the transaction into the government’s utility function.

• Substituting Eqs. (5), (6) and the constraint into (10), the government’s problem becomes:

• Equilibrium bank privatization contracts are characterized by two first order conditions which must be jointly satisfied:

• In short, (12) implies that government maximizes a weighted average of its net income and the value of patronage jobs. (13) implies that xr is determined independent of the relative weights given by the government to monetary resources and patronage jobs (KM and KL).

Comparative statics • Jobs protected by the government • From Eq. (12), we fined:

• Changes in KM and KL affect the price that the buyer is willing to pay for its share of the privatization bank. From Eq. (6):

• Assets assumed by the purchaser • From Eq. (13):

•

We assume:

•

For the simplicity we also assume that private owners and managers of the residual entity are equally good at managing their respective portfolios and that there are constant returns to scale in managing assets. That is, we assume:

•

where c[ is a constant. Under these functional form assumptions (and denoting ]^s= ]s/ x\pub), Eq. (15) implies:

•

This implies:

• Increase in ]r will result in higher equilibrium values of xr^.

• This means that when the privatized bank is relatively good at recovering assets. It will assume a greater share of the former public bank’s assets.

• Empirical Results • In this subsection, we empirically test some of the predictions of the theoretical model, looking at the characteristics of the banks and provinces that affected the privatization contracts. • We are primarily interested in factors that might affect either the preferences of policymakers (i.e., that might correspond to KM and KL in the theoretical model), the risk associated with banking (i.e., that might correspond to ]s ) or the attractiveness of the bank to potential buyers (i.e., that might affect the quality of buyer and, therefore, influence ]r ).

• The model that we estimate is:

• where i is the index for different banks, yi represents the contract provisions, xi represents province- and bank-level characteristics, and _i is an error term. • The contract provisions studied that relate directly to the theoretical model are: restrictions on layoffs (L); the percent of public bank assets taken by the privatized bank rather than put into the residual entity (xr); and the price paid relative to size of the bank (Pb). • The independent variables include two that might proxy for politician’s preferences (i.e., KM and KL) and three variables that might affect the probability of insolvency (]s ) or how attractive buyers find the bank, which might in turn affect the quality of the buyer (]r ). the political affiliation of the governor appears to be a reasonable proxy for preferences regarding bank privatization in Argentina.

• In practice, the reverse seems true—provinces with dominant public banks managed to impose fewer restrictions on layoffs and assumed a greater share of the public bank’s assets and liabilities. The coefficient on the length of the service contract was also positive and significant. This is consistent with the previous two results—contract provisions were more generous to the buyer when the bank was relatively large. This could be because public provincial banks tended to be especially large (relative to the banking sector) in sparsely populated rural provinces, which tend to be unattractive banking environments. The coefficients on the size of the public bank relative to the provincial banking sector were insignificant in the other two equations (price and percent of the portfolio that was guaranteed).

Conclusion • Argentina’s provincial bank privatizations of the 1990s offer a unique opportunity to study these issues. During this privatization episode, different provincial politicians, who faced different constraints, crafted agreements with private purchasers for the sale of their lossmaking public banks. Since the privatization contracts differed substantially in some regards, this provides an opportunity to explore how the different incentives and constraints facing different decision makers affected contract design. • Although we recognize that our sample is quite small, the empirical evidence supports a number of the theoretical predictions. For example, politicians in provinces with poor fiscal health were able to preserve jobs for fewer bank employees and received higher payments for their banks. In addition, the evidence suggests that the Tequila Crisis meant that politicians could protect fewer jobs and had to assume a higher share of their public banks’ assets.

• Finally, our model predicted that when buyers had less expertise in managing a loan portfolio, smaller portions of the loan portfolio would be transferred to the privatized bank. In locations where the provincial bank dominated the local financial landscape, and buyers were presumably difficult to attract, this appears to be the case. • In practice, this is difficult to fully assess in Argentina due to the relatively short post-privatization experience for most banks and because the banks are still going through an equilibration process as they refocus their business activities towards commercial lending. However, there is some evidence that banks privatized after the Tequila Crisis have performed better than those privatized before the crisis. This suggests that the Crisis may have wrought some unforeseen benefits by tying politicians’ hands.

References • 1-Robin A. Johnson and Norman Walzer.” local government innovation: issues and trends in privatization and managed competition”.2000 • 2-Saebi m.;” privatization in the Republic of Iran” , Asian review of administrative, Vol. XI,No.2(July_December 1999). • 3-”Terms related to privatization activitiesand processes” GAO/GGD97-121,July 1997. • 4-Tongzon J.,Heng W.” Port privatization, efficiency andcompetitivness”.Transportastion research part A 39(2005) pp405424. • 5-Button K., McDougall G.;”Institutational and structure changes in air navigation service-providing organization”; Journal of Air transportation management 12(2006) pp236-252. • 6-Clarke G.R.G, Cull r.;” Bank privatization in Argentina”; Journal ofDevelopment Economics 78(2005)pp1333-155.

• 7-WWW.madaan.com. • 8-S. Kulkurni. And A. Sharma.;’ Supply Chain Management’; Chapter 12. • 9-M. Boyer.;’ Foundation of public outsourcing’. • 10-K. M. Rich.;’ Perspectives on the Supply Chain Management of High-Value Agriculture: The Role of PPP’s in Promoting Smallholder Access’; International Conference on Public-Private Partnerships for Harnessing the Potential of Rainfed Agriculture; 2005. • 11-J. V. Braum.;’ Pro-Poor Public-Private Partnerships (“5P”) in Food and Agriculture’; Conference on Public-Private Partnerships for Harnessing the Potential of Rainfed Agriculture; 2005. • 12-http:// www. Ozemail. com. au. • 13- www.unglobalcompact.org.