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While privatization might offer the potential for increased efficiency and flexibility in delivering social services, appraisals of state and local efforts to privatize have revealed a number of challenges that government agencies must address if contracting is to be successful. Among the many hurdles that officials face, seven issues receive special emphasis in the literature: (1) guaranteeing a competitive bidding environment, (2) developing effective requests for proposals (RFPs) and contracts, (3) monitoring contractor performance, (4) addressing political opposition, (5) involving community-based organizations, (6) avoiding "brain drain," and (7) protecting the integrity of the procurement process. This chapter discusses each of these challenges in turn and, when applicable, notes strategies proposed to address them.
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While proponents of privatization argue that service improvements and cost efficiencies will arise, in large part through the incentives inherent in a competitive market, Sclar (2000) and others point out that the market in which government contracting takes place might not realize this ideal, for a number of reasons. One factor that frequently contributes to an imperfect market for social service privatization is a limited number of qualified providers. Because of the specialized nature of social service delivery--which, in many cases, requires well-trained professionals and imposes significant start-up costs--the pool of capable contractors might be quite small. In these situations, bidders have reduced incentives to minimize costs and operate more efficiently (Sclar 2000; GAO 1997b; Cohen and Eimicke 2001b). A desire for continuity in service provision can also hinder switching among potential service providers, further restricting the choices available to public agencies (Kettl 1993). One tool for encouraging providers to enter a market is government grants for "capacity building" within these organizations. Another possibility is to offer payment terms that help cover the costs of contractor expansion, such as the purchase of facilities or the hiring of new staff (Cohen and Eimicke 2001b). Both these approaches to increasing competition, however, reduce any potential cost savings from privatization, at least in the short run.
Lack of complete information--about the actual costs of providing services or the abilities of contractors--might erode the benefits of a competitive market. A government agency awarding a contract cannot make the most favorable decision, in terms of price and quality, without such knowledge (Sclar 2000). The result may be poor services for clients at a cost above what the agency would pay if it provided the services directly. This type of market failure is especially problematic in the context of social services, where quality service provision is both highly important and difficult to confirm (Blank 1999).
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Another challenge is the complexity of establishing relationships between the government and private-sector organizations through requests for proposals and contracts (Sclar 2000; Yates 1998; Cohen and Eimicke 2001a). When well designed, these documents create a durable understanding about the services the contractor will offer and the cost. Insufficient detail or clarity in contract language, on the other hand, can lead to confusion regarding basic issues such as the frequency of service provision, arrangements for billing and payment, and standards for data collection and reporting (Yates 1998; Cohen and Eimicke 2001).
Effective contracting relationships begin with a suitable match between the services required and the type of contract drafted. Governments might use at least three varieties of contracts, each presenting specific advantages and disadvantages:
Contracts may incorporate more than one of these approaches. For example, a cost-reimbursement contract might be combined with an incentive structure, so that a service provider's total compensation is based both on costs and the achievement of desired goals.
The advantage of a fixed price contract is predictability--both the service provider and the government agency know in advance how much will be paid--but it is not easily adapted to unforeseen circumstances such as excess service demand or operational costs. Contractors also might have the incentive to reduce the quality of the service. In contrast, a cost-reimbursement contract reduces financial risks for the contractor, but provides no incentive for the contractor to reduce costs and potentially obligates the public agency to spend more for the service than it has budgeted.
Performance-based contracts, if well defined and monitored, can create incentives for service providers to meet the government's objectives. However, these incentives can lead to unintended consequences. For example, if payment is made for employment but not for job retention, the service provider might not have the incentive to find a job that is a good match for the client. If payment is made only on the basis of employment outcomes, the provider may have the incentive to "cream,'' recruiting most aggressively the easier-to-employ clients. In addition, collecting the documentation necessary to verify that the contractor has met the performance targets can be burdensome. Another issue arising with performance-based contracts is that payment might not be made until some time after the costs are incurred. This can cause cash-flow problems, especially for smaller contractors. Finally, performance-based contracts can place contractors at considerable financial risk if the flow of clients to the contractor is not as expected or if unexpected changes in the economy occur.
The drawbacks of performance-based contracts led one state agency, the Pennsylvania Department of Public Welfare (DPW), to switch from performance-based to cost-reimbursement contracts to operate its employment retention program, Community Solutions (Paulsell and Stieglitz 2001). Initially, the contracts were all purely performance-based, with payments based on a client completing a five-day assessment and reporting for the first day of program participation, job placement, and job retention. Many contractors faced financial problems under these contracts because they hired staff to serve the expected number of participants, but referrals turned out to be lower than expected. Moreover, the payment system was challenging to implement for both DPW and the Community Solutions contractors. Contractors had to obtain documentation necessary to report and substantiate participant outcomes and then request payment for achieving performance goals. DPW then had to compare the contractors' reports with participant data collected in its management information system. Payments were not made until the documentation was available and any discrepancies between the information provided by contractors and information collected by DPW were resolved.
In general, prior research suggests that several characteristics distinguish effective RFPs and contracting arrangements (Cohen and Eimicke 2001a, 2001b; Yates 1998; GAO 1997b and 1999; Johnston and Romzek 2000). These include a well-defined request for services, a carefully designed incentive structure that focuses on results instead of outputs or program rules, and the freedom to renegotiate contract terms as necessary. Specific service requests and correct incentives increase the likelihood that government agencies and contractors will work toward common goals. The ability to renegotiate contracts permits a constructive response to new circumstances or to contracting arrangements that do not function as planned.
An additional prerequisite for effective contracting is the capacity within government agencies and private contractors to develop productive and fair agreements. Johnston and Romzek (2000), studying contract implementation in Kansas, note that "executing a contract prove[d] to be surprisingly difficult for all parties involved." Substantial attention to detail, understanding of program components, and knowledge of applicable laws and regulations are necessary for the process to move forward smoothly. Government staff new to contract management--including those with substantial experience in program operation--might require specific training and mentoring in order to develop this expertise (Cohen and Eimicke 2001b; Yates 1998).
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Once a government agency has entered into a contract with a private service provider, it faces the challenge of verifying that the services delivered meet expected standards for implementation and quality. This entails the development and use of accurate performance measures, a task that the literature identifies as both particularly difficult and essential to successful privatization of social services (Kammerman and Kahn 1998; GAO 1997b; Sclar 2000). Creating measures of contractor performance and refining them to suit a specific program frequently require time and experimentation. It is especially difficult to identify and measure desired results for social services. This is because the objectives of many social services, including improved family and child well-being, are often difficult to define simply and clearly.
The challenge of contract monitoring extends not only to the definition of performance measures, but to the mechanics of the measurement process as well. Government agencies and contractors must decide who will conduct the monitoring, how data will be collected and reported, and how feedback will be communicated (Johnston and Romzek 2000). Without deliberate attention to these details, the value and impact of the monitoring system may be undermined. To ensure effective monitoring, many contracting agencies would need to invest heavily in staff training.
Although monitoring can serve as a beneficial link between government agencies and contractors, observers have noted that conflict occasionally arises between government demands for accountability and contractors' interest in maintaining autonomy (Frumkin 2001). This issue is especially salient for nonprofit organizations that see themselves as social innovators. Well-designed incentive structures have helped resolve this conflict in some instances. Under a "milestone payment system" used in Oklahoma, for example, contractors are compensated as they accomplish a set of predetermined program results, which were designed cooperatively by the service provider and the government agency (Frumkin 2001). Generally, the nature of the service being provided, and the risks that outsourcing poses to clients and the government, will affect decisions about the proper balance between promoting innovation through outsourcing and maintaining direct control over program operations (Blank 1999; Cohen 1999).
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Some state and local governments wishing to privatize services have faced considerable political opposition from unions and advocacy groups. Public sector unions such as the American Federation of State, County, and Municipal Employees have been among the most determined foes of privatization. Concerns over job security have led these groups to publicize scandals and poor performance among contractors or to file suits challenging the authority of government agencies to contract out specific services (SEIU 1997). Meanwhile, organizations such as the Applied Research Center voice skepticism over the ability of private-sector firms to maximize value for shareholders and safeguard the public interest simultaneously (Berkowitz 2001).
To address this opposition, governments have implemented strategies for "workforce transition," including involving public employees in privatization planning, offering training in skills necessary for implementing privatization, and providing special benefits for workers displaced due to the privatization of services (GAO 1997c). In some localities, public employees have themselves been invited to vie for contracts against private companies (Sclar 2000).
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The entrance of for-profit corporations into the market for social service contracts raises questions among some observers about the viability of nonprofit organizations in a newly competitive environment. While local nonprofits often contribute in important ways to their communities, they might not have the financial or organizational wherewithal to compete successfully against well-capitalized corporations. A lack of financial assets is especially problematic when the government does not reimburse the full cost of the employment services until the client is placed in employment. The small size of most community-based organizations also can prevent them from realizing the economies of scale and cost savings of larger companies. Some community-based organizations perceive a conflict between their core missions, which emphasize responsiveness to client needs, and pressures to establish new priorities--such as accurately measuring performance and improving cost efficiency (Sanger 2001; Saxon-Harrold and Heffron 1999). Sanger (2001) expresses the concern that for-profit corporations will capture a sizable portion of government funding that formerly supported community-based organizations, a shift could that weaken the social infrastructure in needy communities and put the traditional clients of community-based organizations at risk.
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Close working relationships between governments and contractors create another set of potential challenges to privatization. In some instances, private organizations that have received government contracts begin recruiting employees of public agencies to access the talent necessary for implementing and operating programs (Sanger 2001). GAO research on senior staff turnover in child support and TANF programs offers evidence of this. Of senior program directors who left their positions from 1993 to 1998, 25 percent went to work for private contractors providing TANF or child support services. A major reason for these departures was the opportunity to earn a higher salary (GAO 1999). The loss of personnel--both management and those with specialized expertise in areas such as information technology--can affect government agencies' ability to design and monitor contracts effectively as well as to deliver services again once the contract expires.
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Government agencies, both at the federal and state levels, have long recognized the potential for conflict of interest in the procurement process. Indeed, allegations of unlawful lobbying or irregularities in the contracting process have dogged several private providers of social services (Berkowitz 2001; Hartung and Washburn 1998). Some have argued that the so-called “revolving door,” the movement of employees between the public and private sectors, could give contractors with former government employees an unfair advantage. However, a GAO study of TANF and child support enforcement contracts in four states found that listing former government employees as key personnel did not increase the chance of a bid’s success. In response to concerns about the integrity of the procurement process, most states have established some ethics policies designed to help ensure open and fair procurement (GAO 1999).
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