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IIAS Series: Governance and Public Management

International Institute of Administrative Sciences (IIAS) –


Improving Administrative Sciences Worldwide

The International Institute of Administrative Sciences (IIAS) is a NGO with


scientific purpose established in 1930 whose seat is still in Brussels.
The Institute is a worldwide platform providing a space for exchanges that pro-
mote knowledge and practices to improve the organization and operation of
Public Administration and to ensure that public agencies will be in a position to
better respond to the current and future expectations and needs of society.
It thus provides a forum where practical experiences and theoretical analyses of
experts (academics and practitioners) in public administration worldwide and
from all cultures are presented and discussed.
To cover the diversity of its members, the IIAS has set up four sub-entities:
– The EGPA (European Group for Public Administration)
– The IASIA (International Association of Schools and Institutes of
Administration)
– The LAGPA (Latin American Group for Public Administration)
– The AGPA (Asian Group for Public Administration)
Website: http://www.iias-iisa.org
Governance and Public Management Series
Series edited by:
Gérard Timsit, Emeritus Professor, University of Paris I Panthéon
Sorbonne (France)
Taco Brandsen, Professor, Radboud Universiteit Nijmegen (The Netherlands)
Editorial Series Committee
Gérard Timsit, IIAS Publications Director and Series Editor
Rolet Loretan, IIAS Director General
Taco Brandsen, Member and Series Editor
Michiel De Vries, Member
Christopher Pollitt, Member, IRAS Editor in Chief
Fabienne Maron, IIAS Scientific Administrator and Publications Coordinator
The Governance and Public Management series, published in conjunction with the
International Institute of Administrative Sciences (IIAS), brings the best research
in public administration and management to a global audience. Encouraging a
diversity of approach and perspective, the series reflects the Institute’s conviction
for a neutral and objective voice, grounded in the exigency of fact. How is gov-
ernance conducted now? How could it be done better? What defines the law
of administration and the management of public affairs, and can their imple-
mentation be enhanced? Such questions lie behind the Institute’s core value of
accountability: those who exercise authority must account for its use – to those
on whose behalf they act.

Governance and Public Management series

Titles in the series include:


Pekka Valkama, Stephen J. Bailey and Ari-Veikko Anttiroiko (editors)
ORGANIZATIONAL INNOVATION IN PUBLIC SERVICES
Forms and Governance
Victor Bekkers, Jurian Edelenbos and Bram Steijn (editors)
INNOVATION IN THE PUBLIC SECTOR
Linking Capacity and Leadership
Michiel S. De Vries
THE IMPORTANCE OF NEGLECT IN POLICY-MAKING
Michiel S. De Vries, P. S. Reddy and M. Shamsul Haque (editors)
IMPROVING LOCAL GOVERNMENT
Outcomes of Comparative Research
Michiel S. De Vries and Pan Suk Kim (editors)
VALUE AND VIRTUE IN PUBLIC ADMINISTRATION
A Comparative Perspective
Wouter Van Dooren and Steven Van de Walle (editors)
PERFORMANCE INFORMATION IN THE PUBLIC SECTOR
Per Lægreid and Koen Verhoest (editors)
GOVERNANCE OF PUBLIC SECTOR ORGANIZATIONS
Proliferation, Autonomy and Performance
Eberhard Bohne
THE WORLD TRADE ORGANIZATION
Institutional Development and Reform

Governance and Public Management Series


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Organizational Innovation
in Public Services
Forms and Governance

Edited by

Pekka Valkama
Research Director, School of Management, University of Tampere,
Finland and Adjunct Professor, Turku School of Economics,
University of Turku, Finland

Stephen J. Bailey
Distinguished Professor, School of Management, University of Tampere,
Finland and Emeritus Professor of Public Sector Economics,
Glasgow Caledonian University, UK

and

Ari-Veikko Anttiroiko
Adjunct Professor, School of Management, University of Tampere, Finland
Selection, introduction and editorial matter © Pekka Valkama,
Stephen J. Bailey and Ari-Veikko Anttiroiko 2013
Remaining chapters © Respective authors 2013
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Contents

List of Tables, Figures and Boxes vii


Preface and Acknowledgements viii
Notes on Contributors ix

Part I Background and Analytical Framework


1 Contexts and Challenges of Organizational Innovation
in Public Services 3
Pekka Valkama, Stephen J. Bailey and Ari-Veikko Anttiroiko
2 Supporting Organizational Innovation in the
Public Sector: Creative Councils in England 13
Paul Roberts and Stephen J. Bailey
3 Analyzing Organizational Innovation in
Public Services – Conceptual and Theoretical Issues 27
Pekka Valkama, Stephen J. Bailey and Ari-Veikko Anttiroiko
Part II The Process of Organizational Innovations
4 Agencification Processes and Agency Governance:
Organizational Innovation at a Global Scale? 49
Koen Verhoest
5 Corporatization as Organizational Innovation 72
Pekka Valkama
6 Mutualization and Public Services 92
Mel Evans
7 Organizational Innovation in Public Procurement
in Scotland: The Scottish Futures Trust 111
Darinka Asenova
8 Outsourcing Public Services: Process Innovation
in Dutch Municipalities 130
Alex D. R. Corra and Jacobus de Ridder
Part III Governance of New Organizational Forms
9 Governance of Public Service Companies: Australian
Cases and Examples 151
Anona Armstrong
v
vi Contents

10 Governance of Social Enterprises as Producers


of Public Services 170
Isabel Vidal
11 Championing and Governing UK Public Service Mutuals 187
Jane Tinkler and Paul Rainford
12 Improving Governance Arrangements for Academic
Entrepreneurships 202
Matthew S. Wood
13 Governance and Accountability of Joint Ventures:
A Swedish Case Study 221
Anna Thomasson and Giuseppe Grossi
14 Contractual Governance: A Social Learning Perspective 238
Peter Vincent-Jones
Part IV Conclusions and Discussion
15 Lessons for the Governance of Organizational
Innovations 259
Stephen J. Bailey, Pekka Valkama and Ari-Veikko Anttiroiko

Index 270
List of Tables, Figures and Boxes

Tables

3.1 Categorizing organizational forms and relationships


of public service delivery 32
3.2 Internal and external governance mechanisms
in charity sector 39
4.1 Three agency governance models and their
critical building blocks 57
7.1 Similarities and differences between the standard
PFI/PPP and the NPD model 118
9.1 Contrasting forms of governance in the public sector 163
13.1 Vertical and horizontal relationships in joint ventures 224

Figures

3.1 Generic options for organizing public services 30


3.2 Key organizational dimensions from a public
management perspective 36
5.1 The holistic process model of corporatization 81
7.1 The main milestones in the SNP’s development
of the SFT 113

Boxes

10.1 Transformation of a quango into a social enterprise


example: Red Cross Catalonia 173
10.2 Suara Cooperative 174

vii
Preface and Acknowledgements

The considerable scope for organizational innovation in public service


sectors is not widely appreciated. The chapters in this book demonstrate
that there is, in fact, significant potential for innovation in the provi-
sion of public services through such specific means as agencification,
corporatization, mutualization, social enterprises, outsourcing and other
forms of public procurement and case studies demonstrate the processes
required to introduce these new organizational forms. However, for that
potential to be achieved in terms of delivering increased public value,
appropriate arrangements for governance of these new organizational
forms also need to be put in place and further analyses and case stud-
ies show how this can be achieved and lessons are drawn accordingly.
Ultimately, however, whether such improvements are achieved depends
on contexts, support mechanisms, regulation reforms and how those
innovations are conceptualized and analyzed, as made clear in the
introductory chapters.
The editors express their thanks to the Finnish Funding Agency for
Technology and Innovation (Tekes), which financed all three of them
on two separate innovation projects during the preparation of this
book while employed by the School of Management of the University
of Tampere, Finland.

Pekka Valkama, Stephen J. Bailey, Ari-Veikko Anttiroiko


March 2013, Tampere, Finland

viii
Notes on Contributors

Ari-Veikko Anttiroiko is Adjunct Professor at the School of Management


at the University of Tampere, Finland.
Anona Armstrong is Professor of Governance and Head of the Governance
Research Program at the College of Law and Justice, Victoria University
Australia, Australia.
Darinka Asenova is Professor of Risk and Governance at the Glasgow
School for Business and Society, Glasgow Caledonian University, UK.
Stephen J. Bailey is Emeritus Professor at the Glasgow School for Business
and Society, Glasgow Caledonian University, UK and Distinguished
Visiting Professor at the School of Management, University of Tampere,
Finland.
Alex D. R. Corra is a post-doctoral researcher at the research group on
New Welfare Governance with the Department of Public Administration
and Public Policy Studies at the VU University Amsterdam, Amsterdam,
The Netherlands.
Mel Evans is Director of Programmes for Social Science and Principal
Lecturer in Housing and Regeneration, Department of Law, Middlesex
University, London, UK.
Giuseppe Grossi is Professor and Research Leader of Governance,
Regulation, Internationalization and Performance (GRIP) at Kristianstad
University, Sweden.
Paul Rainford is a research associate of the LSE Public Policy Group at
the London School of Economics and Political Science, UK.
Jacobus de Ridder is Professor of Public Administration at the Faculty
of Law, University of Groningen, The Netherlands.
Paul Roberts is a director at the Innovation Unit, UK.
Anna Thomasson is an assistant professor at the School of Economics
and Management, Lund University, Sweden.
Jane Tinkler is Research Fellow and Manager of the LSE Public Policy
Group at the London School of Economics and Political Science, UK.

ix
x Notes on Contributors

Pekka Valkama is Research Director at the School of Management,


University of Tampere, Finland and Adjunct Professor at the Turku School
of Economics, University of Turku, Finland.
Koen Verhoest holds a Research Professorship ‘Comparative Public
Administration and Globalization’ at the Public Administration &
Management Research Group, Department of Political Science, University
of Antwerp, Belgium.
Isabel Vidal is a professor in the Faculty of Economics and Business at
the University of Barcelona, Spain.
Peter Vincent-Jones is Professor of Law at the School of Law, University
of Sheffield, UK.
Matthew S. Wood is an assistant professor of Management and
Entrepreneurship at the Hankamer School of Business, Baylor University,
USA.
Part I
Background and Analytical
Framework
1
Contexts and Challenges of
Organizational Innovation in
Public Services
Pekka Valkama, Stephen J. Bailey and Ari-Veikko Anttiroiko

The rationale for innovation

Innovation underpins the process of economic growth because it is intrin-


sically linked to changes in the systems of production and consumption.
Indeed, the strong growth of national economies and social welfare sys-
tems does not occur simply by scaling up existing organizational activi-
ties and structures. Instead, it involves innovation-based endogenous
and creative economic evolution processes that result in fundamental
changes in the way organizations are structured, how they work, how
they are governed and how relationships between different organizations
are arranged.
The classic prerequisite of productivity improvements is the increased
flexibility of the production process. Increased specialization is also needed
because it creates conditions favorable for the accumulation of expertise
and standardization of routines (Potts 2009; Maroto-Sánchez 2010).
Globalization of markets and increased competition between enter-
prises and nations has increased the pressure to improve productivity in
all parts of national economies. Public sector service organizations have
an integral part to play in the processes of economic growth, because
public services provide the foundation for other economic activities and
platforms for the creation of modern economic and trade networks.
The dynamic advancement of public service systems depends on how
public service organizations are structured and are able to renew their
public service offerings, and this reflects the changing nature of citizens’
needs and evolving problems faced by the collective action of com-
munities. There are growing demands for enabling innovations that
can help to modernize public sector organizations and adjust public
responses to local and global developments.

3
4 Organizational Innovation in Public Services

A public service organization is typically labor intensive and produces


services such as education and health care services. Others provide
public works and utilities services, combining technology, informa-
tion, physical infrastructure and human resources to meet service users’
needs, taking political and other objectives into account. Both types of
service have to pursue good public governance in the changing circum-
stances as best as they can (Ferlie et al. 2003, 1–2).
Within the Schumpeterian perspective, innovation is part of the
economic process of ‘creative destruction’ whereby new and improved
products and processes displace those failing to keep up with market
demands and meeting rising expectations. Popularized in the 1950s as
an explanation of the capitalist process, it may be thought that creative
destruction is not consistent with public services because it can lead
to instability in service supply and, if so, detract from public value.
Bankruptcies and liquidation proceedings in private sector business
operations are not well suited to public sector services. Moreover, the
success of public sector innovations cannot be assessed by profits and
market shares.
Evaluation of public services focuses on outcome effectiveness,
namely the extent to which a service achieves its public policy objec-
tives. This is achieved not only by improved productivity promoting
economy, efficiency and cost-effectiveness but also by services provid-
ing sustainable solutions to social problems, delivering added values
for service users and all citizens. Outcome objectives may also seek to
promote equality and social cohesion, non-trading public services being
provided on the basis of needs rather than on ability to pay.
Finances are finite, however, and so innovation is necessary to con-
tinuously improve the productivity of limited resources and thus bet-
ter achieve service objectives as well as support the competitiveness of
nations and communities. Put simply, innovation is the life blood of
economy and society and is being seen to be increasingly necessary due
to changing contexts.

The evolving context

Organizational changes reflect their historical context, including the


political climate, the dominance of a particular management doctrine,
the level of technological sophistication, institutional and legal envi-
ronments and culture. Public service systems expanded throughout the
Western world as welfare states grew, especially after 1945, creating the
conditions for administrative and publicly funded arrangements for
Contexts and Challenges 5

many functions previously undertaken by individuals, families, neigh-


borhood organizations, local communities and charities.
The growth of public interventions and services was based on the
traditional Weberian-style bureaucracy with hierarchical structures, for-
malized service procedures and role-oriented civil servants. This resulted
in highly bureaucratic and monolithic public service organizations.
Public service organizations have been planned mainly in response to
legislation, creating new sets of public services to achieve political, social
and economic objectives. Public service organizations have typically
worked without autonomy, being managed through annual budgetary
control systems, a routine chain of commands and procedural rules
and regulations set by superior authorities. Service operations are pre-
pared through detailed advance programming and planning, and staff
members have had strict legal responsibilities (Meier and Hill 2005).
Public service organizations have been built on ideas of continuity
and stability, in-house production of public services and governmental
bureaus. Evolution of global politics has increased cooperation between
governments and political groups, promoting experimentation with
administrative reforms, liberalization and integration of regional mar-
kets. Changes in political cultures have moderated the juxtaposition of
left-wing and right-wing groups and increased the competition for votes
among the political parties. At the same time, the grasp of the central
administration has loosened in many countries as decentralization
and devolution of decision-making powers to regional and local levels
have created opportunities for locally tailored arrangements of public
services.
Theoretical developments have also become increasingly influential.
Theories of public choice and quasi-markets (i.e., managed competitive
systems) hold that public services are ineffective due to incentive prob-
lems, self-serving bureaucrats and lack of competition in service delivery.
In response to these issues, the New Public Management (NPM) discourse
promoted the applicability of business-like management practices in the
public sector and inspired many public sector organizations to seek to
introduce enterprise-style accountability and incentive systems. NPM
promotes replacement of hierarchies and bureaus by managerial-based
approaches, utilizing a wide set of management tools to address the
problems of traditional Weberian-style public administration.
Although NPM-based administrative reforms and quasi-market
arrangements have developed rapidly and extensively, their claimed
beneficial effects may have been exaggerated, and classic public admin-
istration seems resilient (Osborne 2010, 2). Moreover, at least until the
6 Organizational Innovation in Public Services

onset of the European Union (EU) Eurozone crisis in 2010, public sec-
tors did not shrink even as Western governments pursued market-based
solutions and managerial approaches to service provision: in fact quite
the opposite occurred.
Governments have tended to spend more on public services than they
collect in revenue from taxes and other income sources, creating ‘black
holes’ or ‘structural gaps’ in the public finances by borrowing year-after-
year and decade-after-decade even when tax revenues were booming
during periods of fast economic growth from the 1960s onward (Bailey
2004). Until very recently, these structural gaps were supported by the
willingness of globalized financial markets to continue to lend money
to governments (and individuals) in the belief that growing prosperity
would enable them to repay debt. This was accompanied by lack of
financial transparency and a poor appreciation of the increasingly risky
nature of banking and finance operations. As a consequence, many
Western governments became exposed to increasingly severe difficul-
ties in refinancing their debt, brought to a head by the global 2007–09
credit crunch within the financial sector and the subsequent Eurozone
crisis. Increasingly risk-averse global financial markets have forced many
Western governments to quickly introduce policy measures intended to
improve their country’s economic competitiveness, especially reforms of
labor markets, welfare systems and industrial and economic structures.
This credit-rationed financial environment has created increased
impetus to take advantage of new opportunities for organizational
innovations as governments look desperately for solutions to economic,
financial and social problems and yet seek ways of achieving significant
budgetary savings. Governments in most developed countries now seek
to introduce public sector reforms to reduce their budget deficits and
thereby fill the black holes in their public finances. It is a cliché that
opportunities arise out of a crisis, but the time is now ripe for widening
and deepening organizational innovation in public sectors. In doing so,
however, the changing technological and teleological nature of public
services within ‘the new service economy’ has to be taken into account.

Emergence of the new service economy

In the era of industrial economies, economic values were created pre-


dominantly locally, in-house and mechanistically. However, manufactur-
ing reached its peak as a share of gross domestic product (GDP) in many
developed countries during the late 1960s. During the late 20th century,
developed countries became characterized by deindustrialization as
Contexts and Challenges 7

they evolved into service economies, public and private sector services
together accounting for much greater shares of GDP and employment
than manufacturing.
The ‘new service economy’ refers also to radical changes in the nature
and operational principles of service industries, their transformation
being caused by changes in the social, legal and economic environment
and by the latest technological innovations (Zysman 2006; Zysman
et al. 2011). Manufacturers now subcontract to external providers many
of their ‘unbundled’ formerly in-house vertically integrated activities,
creating service clusters and ecosystems around physical products.
The emergence of the new service economy has challenged tradi-
tional ways of working, as many services can now be codified, formal-
ized and modularized by information and communication technology
(ICT). As a result, some public services have become more mobile and
easily tradable because global communication and information delivery
costs have been reduced very substantially by digitization.
Complementing this technological transformation, globalization and
liberalization promote development of the networked service economy in
which capacity, risks and, especially, knowledge can be shared relatively
easily and new value-chain models can be created. Some networks are
platforms for building up alliances and partnerships, which may help to
gain access to new input or output markets and favorable treatment in
public policy forums (Zysman 2006; Zysman et al. 2011; de Man 2004, 4;
Bessant and Tidd 2007, 85; Furubotn and Richter 2005, 308–310).
Know-how and other intangible resources will acquire greater relevance
as input factors even though some service sectors may be as capital inten-
sive as some manufacturing industries (Akehurst 2008, 3). Completely
new service industries and professions will develop as services are recon-
figured through value-extracting, value-adding and value-capturing
activities based on intensification and deepening of knowledge systems.
New opportunities for service operations will arise from not only unbun-
dling but also rebundling of the range of services (Sweet 2001, 72–73).
Property rights are crucial for physical manufactured products, but in
the new service economy such issues as access rights, time-limited use
rights, renting and leasing arrangements and joint consumption will
feature strongly as services become seen as a means to share, accumulate
and refine resources (Akehurst 2008, 5).
Because many publicly funded service sectors have been and will
remain heavily regulated, the challenge for policy makers will not be
how to deregulate services, but instead how to change the way they are
regulated in order to develop quasi-markets and generate new service
8 Organizational Innovation in Public Services

sector institutions, adjusting regulatory policies in step with the


changing logic of value creation (Landy and Levin 2007; Vogel 2007).
Expressed in a different way, rather than introducing light-touch regu-
lation to maximize economic value (the neoliberal policy increasingly
adopted during the 1990s and early 2000s), the approach in the new
service economy has to be appropriate-touch regulation to maximize
social value.
Judging value creation of services in neoliberal terms as value-in-
exchange is too narrow a perspective because service users are increas-
ingly being regarded as active participants in setting service objectives,
in service design and in service processes to achieve those objectives,
rather than simply being passive customers. As a crucial part of the
value-creation process, service clients add value through their use of
service outputs as they interact with service providers to cocreate serv-
ice outcomes within the context of a wider service system comprising
lawmakers, intermediaries, subcontractors, regulators and other stake-
holders (Paton and McLaughlin 2008, 79; Vargo et al. 2008; Tien 2007,
66–67; Gallaher et al. 2006, 7–11, 117). However, this teleological, as well
as technological, approach to innovation in public services faces many
challenges.

Challenges for public service innovations

Organizational innovations in the public sector face many challenges


as they aim for radical rethinking and redesign of public service sys-
tems and seek to transform service units into more adaptive learning
organizations through more entrepreneurial behavior. Many policy
makers have begun to realize that a wide set of potential benefits can be
achieved through interorganizational linkages and by joint working (i.e.
collaboration) with the private, para-private and para-public sectors, but
such transformation is problematic.
Conventionally, public and private service processes have been
separated value chains and have followed different organizational struc-
tures. Blurring organizational boundaries and expanding cross-sectoral
contractual relationships exchange and rotate the operations and duties
between the government sector, community organizations and business
enterprises and open up possibilities for knowledge transfer and revolu-
tionary service combinations where complementary service industries
can cooperate with each other.
This requires public sector organizations to specify and update their
objectives and accountability systems and modernize incentives for
Contexts and Challenges 9

managers, staff and other stakeholders to find novel solutions for classic
government failures arising from imperfect information and the pursuit
of self-interest by bureaucrats and politicians. Otherwise, barriers such
as legally fixed boundaries, customary functions or monopoly power
may prevent or slow down technological and teleological innovations.
Typical barriers to innovation in public services have included lack of
incentives to innovate, poor skills in change management, short-term
public budgets, silo mentality, reluctance to change or close down fail-
ing organizations and a culture of aversion to risk (Albury 2005, 51). The
‘innovation paradox’ is that, on the one hand, there is an imperative for
the virtues of classic bureaucratic public administration with neutral,
distant and standardized organizational forms and service procedures
but, on the other hand, being innovative and improving public services
seems to require flexibility, responsiveness and customer orientation
(Veenswijk 2005, 3).
At the risk of over-generalization, innovation in the public sector
seems to occur despite, rather than because of, the way services are
organized. Public service reorganization has been evolutionary rather
than revolutionary, the emphasis being on incremental (rather than
radical) changes, minimizing the risks associated with change rather
than rewarding those who are the most innovative. This is quite dif-
ferent from the private sector where innovation is seen as inherently
risky but as the key strategy for survival in the long term, bringing com-
mercial rewards to successful innovators. In the public sector, there are
typically no such rewards, only opprobrium and even penalties for fail-
ure, this downside bias explaining adoption of management strategies
to minimize risk via incremental evolutionary change. Revolutionary
change requires effective management and governance of risk.

Aims of this book

The first aim is to promote understanding of the challenges of organiza-


tional innovations from public policy and public management perspec-
tives by providing both practical and theoretical insights. Mainstream
public administration literature has analyzed and evaluated changes in
public agencies as public policy or administrative reforms. In contrast,
this book applies an innovation perspective, which means that atten-
tion has to be paid to the newness, discontinuity and originality of
organizational changes. Hence, the book provides analytical perspec-
tives and up-to-date examples of how new organizational arrangements
and forms are created and governed.
10 Organizational Innovation in Public Services

The second aim is to demonstrate transformation processes and how


public and semipublic organizations are learning from private and third
sector organizations becoming engaged in the delivery of public policy
objectives. Public services are increasingly produced by a wide range
of public, semipublic, charitable and private organizations through
changes of organizational forms and introduction of new organiza-
tional models and networks. This is in sharp contrast with Weberian-
style bureaucracy and its emphasis on in-house production, hierarchical
organizational structures, stable organizational forms, formalized service
procedures and limited managerial autonomy. Chapters illuminate the
radical transformations that rearrange the distribution of work between
governmental units and private and voluntary sector organizations, and
replace public law organizations by private law organizations.
The third aim is to illustrate how organizational innovations renew
the preconditions of public governance and change governance con-
cerns and, in so doing, make exclusive categorization as public or
private sector increasingly inappropriate and analytically unhelpful.
Instead, we need to ask to what extent and in what respects different
aspects of public policy and service are ‘public’ and how this publicness
is manifested in governance solutions (Bovaird and Löffler 2009, 7–8).
A ‘public service’ is a relative concept, and public services are increas-
ingly defined in terms of arrangements for their governance and their
focus on wider public interests rather than on the organizational form
that is used to produce those services. This boils down to the question
of to what extent and by which means are alternative organizational
arrangements controlled and supervised by the government and to
what extent governance functions can be shared with the full range of
stakeholders.

Book structure

This book consists of four parts. This first part contains three introduc-
tory chapters concerned with not only the contextual considerations
but also the theoretical and conceptual perspectives. The second part
focuses on the processes of organizational innovations, including
agencification, corporatization and outsourcing as mega-trends of
radical changes in organizational forms. The third part concentrates on
governance policies and practices of new organizational forms in public
service delivery, including corporate governance of state-owned compa-
nies and multi-stakeholder governance of social enterprises. The fourth
part draws lessons about how to govern organizational innovations and
Contexts and Challenges 11

presents future prospects of organizational innovations. This structure


helps understand organizational innovation as process and result, and
as transformation and effect, of new organizational forms and organiza-
tional governance relationships (Bessant and Tidd 2007, 12).

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2
Supporting Organizational
Innovation in the Public Sector:
Creative Councils in England
Paul Roberts and Stephen J. Bailey

Introduction: Recent innovation initiatives

The development of initiatives to encourage innovation in local govern-


ment in England evolved during an era as from 1996 in which central
government imposed inspection and audit nation-wide. This had its
origin in the inspection of local authorities’ education functions, with
the first pilot inspection of a local education authority (LEA) in 1996,
leading to a rolling program of inspections thereafter that ensured that
all LEAs had been inspected by 2001, under Section 36 of the 1997
Education Act. There were similar central government inspections and
ratings for local authority provision of adult social care. Although these
inspections focused on service standards, they provided the foundations
for the development of central government schemes focused specifically
on innovation.

The Beacon Scheme


The Beacon Scheme for local authorities was introduced in 1999 to
identify excellence in local government, from which others could learn.
Local authorities and other ‘best value’ authorities (e.g., police, fire and
rescue service, national parks) – and increasingly, wider partnerships –
were awarded Beacon status on the strength of excellence in the delivery
of services, supported by good overall performance and effective plans
for spreading good practice. In each round of the scheme, ministers from
different central government departments selected themes under which
authorities could apply for Beacon status. While the program involved
the dissemination of the identified good practice, it did not develop
generic or systemic understandings about local government innova-
tion, nor did it develop an approach or a support system for scaling up,

13
14 Organizational Innovation in Public Services

spreading or embedding innovative practice. For many authorities, the


prize was the recognition through the Beacon award status rather than
the opportunity to engage in the widening of the innovative practice.
The prize of recognition was sought by councils for both political and
professional reasons. The award effectively gave central government
approval of the practices adopted by those councils, along with the poli-
ticians and officers working therein. This could be expected to improve
their chances of re-election and career progression.

The comprehensive performance assessment


In 2002, the Audit Commission introduced an audit regime covering
the full range of local authority functions for top-tier councils – the
Comprehensive Performance Assessment (CPA). The CPA ran from 2002
until 2008 and assigned a rating of excellent, good, weak or poor to each
assessed council. In 2002, only 22 of 150 local authorities were rated as
excellent – a number that rose to 62 by 2008. In 2002, there were 34
local authorities classified as weak or poor – a number that fell to 4 by
2008. The Audit Commission’s perspective on this was that over the
time that the Commission implemented CPA, council services improved
significantly and CPA should be acknowledged to be one of the catalysts
for this.
A very different view from many councils was that the CPA became
a restricting influence on the development of their services, and it is
significant that the sternest criticism of the CPA came from some of the
highest-rated councils. There was severe criticism of the cost to local
authorities of the CPA process (the preparation for it and management
of it) and a growing view that it was becoming a game of playing the
rules to achieve the highest ratings (and in so doing emphasizing cau-
tion and compliance at the expense of innovation).
According to this view, central government’s attempt to microman-
age local government performance in order to improve efficiency in
the short term to medium term only served to stifle innovation in the
long run. Benchmarking was against the best-performing councils, but
those councils were not enabled to raise the bench. It was only later that
councils rated as excellent were freed from micromanagement by central
government, increasing the scope for organizational innovation.

The Innovation Forum


The Innovation Forum was formed in 2003 as part of the CPA arrange-
ments. It was intended to bring together those councils that had
achieved an excellent rating, with the purpose of pioneering ways
Supporting Organizational Innovation in England 15

of delivering improved public services. But again, it was a top-down


approach, funded and steered by the central government. The focus of
the Forum was dictated by central government, and the energy of the
original Forum became thinly spread as councils rated as excellent rose
from 22 to 62.
Notwithstanding these characteristics of the Forum, some interesting
work emerged, for example the reducing hospital admissions of elderly
people needing social rather than medical care, making children’s services
more coherent for parents and families and challenging the obstacles that
centrally driven government targets can put in the way of innovation
in local service delivery. It also led to reflections on innovative practice
that pointed to future tenets regarding innovation in local government.
Leadbeater (2006) argues that many of the best ideas for innovation and
improvement of public services come from those close to the problem
(i.e., frontline staff and users) rather than from the top or centre of the
organization. Innovation requires thoughtful, experienced and skilled
practitioners seeking more effective approaches to service needs, the
emphasis on practitioners being a recognition of the distributed leader-
ship of public service. The approach has to be much more interactive,
whereby ideas are tested, feedback is rapid and continuous and services
are refined accordingly. This process must never stop if organizations are
to capitalize on these ‘distributed sources’ of innovation.
Both the Innovation Forum and the Beacon Scheme were predi-
cated on an assumption that highly rated councils (in CPA or in a
Beacon Scheme application process) were necessarily those most likely
to produce innovative solutions to the increasing challenges facing
local government. However, Nesta (2008) found that innovation was
a response to underperformance. It noted that UK innovation policy
was then almost entirely tailored to the needs of traditional for-profit
science and technology-based innovation and so was underdeveloped
in terms of stimulating social innovation. First, there was insufficient
understanding of the drivers of innovation. Second, there was a lack
of intermediary bodies with the power and resources to facilitate the
growth and dissemination of innovation for full-scale policy devel-
opment and implementation. Third, markets for the results of social
innovation were fragile such that even the most successful innovations
were not guaranteed reliable funders and purchasers. Fourth, local social
innovation is hidden from policy makers and researchers. Fifth, govern-
ment is often perceived as stifling innovation because audit controls,
budget criteria and recruitment policies are not designed to foster social
innovation.
16 Organizational Innovation in Public Services

The improvement and development agency for local government


In addition to the Beacon and Innovation Forum schemes driven by
central government, there were also innovation activities and programs
driven by local government (Parker 2009). These innovations seeking bet-
ter outcomes include a social enterprise model in adult social care, radi-
cal innovation in the design and delivery of education, an approach to
reducing re-offending by focusing on skills and employment rather than
on the offending itself, tackling community cohesion, exploring copro-
duction by developing the role of service users as producers, and develop-
ing the role of communities in measures to combat climate change.
The Improvement and Development Agency (IDeA) for local govern-
ment invested in a program of work led by the Innovation Unit and the
Young Foundation. Called the ‘Innovation Catalyst’, it was designed to
test and develop a more strategic and disciplined approach to support-
ing innovation in local government. In particular, the Catalyst program
was envisaged as a way of creating capacity for the sector to focus on
some of the most difficult and intractable issues faced by councils and
their partners. In addition to work on method and resources for inno-
vation, the Catalyst trialled its model through a practical project with
Knowsley, Sheffield, Essex and Westminster councils to generate and
incubate innovations in the field of youth crime.
Overseen by the Local Government Association, IDeA was later renamed
Local Government Improvement and Development. It uses ‘tried and
tested’ ways of working to support improvement and innovation in
local government by focusing on the issues that are important to
councils, rather than those deemed important by central government.
Hence, it is a bottom-up approach – rather than top-down – and does
not use the award and ratings models developed by the centrally
imposed Beacons and CPA initiatives. Instead, it works with councils to
develop good practices, supporting them in their partnerships through
networks, online communities of practice and web resources.

The Public Services Innovation Laboratory


Notwithstanding these top-down and bottom-up initiatives, barriers can
still trap innovations ‘on location’ and thwart efforts to grow innovation
capacity more systematically across the sector. These barriers include, first,
cultures that favor compliance over innovation; second, performance
regimes, inspection and audit; third, poor mechanisms to diffuse and
disseminate learning; fourth, few risk-taking incentives; and fifth, little
support – financial or otherwise – for investing in innovation work (Parker
2010). As a result, councils are often unable to scale up innovations,
Supporting Organizational Innovation in England 17

moving them from the margins to the mainstream, unable to foster and
sustain innovation in any kind of systematic way. Innovation either
emerges by chance or as a result of work by committed and visionary pro-
fessionals. Hence, innovation tends to be ad hoc rather than embedded
practice, reflecting poor understanding and insufficient evidence about
how to stimulate, sustain and scale up innovation in local government.
Development of the Department for Innovation, Universities and
Skills (DIUS) – which later merged into the Department of Business,
Innovation and Skills (BIS) – reflected the increased interest in innova-
tion in public services and recognition of the afore-noted barriers. In
its 2008 white paper, ‘Innovation Nation’ (DIUS 2008), the UK govern-
ment committed itself to the creation of a Public Services Innovation
Laboratory with funding to support programs and learning relating to
innovation in the field of public services. The Laboratory was to be
hosted by the National Endowment for Science, Technology and the
Arts (Nesta). It created a timely catalyst for a focus on local government
innovation in view of the developing intensity of the financial pressures
mounting in the local government sector.
The years from 2007 to 2011 saw a renewed focus on local govern-
ment innovation in response to the ‘pincer effect’ of, first, a dramati-
cally worsened financial settlement for local government in the context
of the UK recession and national political changes in support of budget
deficit reduction and, second, a significantly more demanding set of
expectations on local government services in a context of seemingly
intractable challenges such as those of an ageing society, the spiralling
cost of social care, ‘green’ expectations and increased unemployment
especially among young people.
Incremental approaches to these challenges were increasingly seen as
forlorn and inadequate. In particular, the short-term focus on ‘salami-
slicing’ budget reductions were increasingly recognized as storing up
subsequent and deeper problems in the long term. This was evident at
both managerial and political level in local government.
This provided a context and catalyst for joint work between organiza-
tions such as Nesta, the Innovation Unit, the Young Foundation and
the Local Government Group (LGG). The developments and programs
established a new appetite and capacity for innovation (rather than
incremental improvement) in the local government sector.

The Creative Councils program


Launched in April 2011 and funded by LGG and Nesta, the Creative
Councils program provides space, legitimacy, impetus and practical
18 Organizational Innovation in Public Services

support for sustainable innovation in local government. It focuses on


‘catching a wave’ of enthusiasm for innovation in local government,
driven by the need for better outcomes at reduced cost (Leadbeater
2011). First, it seeks to support innovations to come to life and have
real impact. Second, it tries to spread those innovations into other areas,
learning how local government can become better at replication and
adaptation of great ideas. Third, it raises the level of evidence and qual-
ity of debate about innovation in local government. Fourth, it develops
a toolkit of innovation skills across local government.

An in-depth look at the Creative Councils program

Councils’ participation in the program


The level of response to the program’s call for proposals from local coun-
cils confirmed that ambition was well-grounded – 137 councils submit-
ted applications to be supported in their innovation plans. This included
78% of county councils, 63% of London boroughs, 56% of Unitary
Authorities and 58% of Metropolitan Councils. This in itself provided
valuable data for an analysis of the state of innovation-readiness within
the local government sector, which made clear the surge in interest and
willingness amongst local authorities stepping up to the innovation
challenge within the context of the most dramatic cuts to local govern-
ment finance in living memory. Despite this surge of interest, 58% of
councils were assessed as either not ready or only demonstrated low
levels of readiness (Wilson and Townsend 2011).
Of applicants to the program, around 30% professed an intention to
introduce coproduction, codesign or co-delivery of services. Coproduction
involves service users in the design and delivery of services. It also refers
to the increasing use of social enterprises, often created from the out-
ward movement of staff from direct local government employment.
Coproduction and use of social enterprises entail new approaches to
governance of these new forms.

The focus of innovation practice


Seventeen councils were selected for first-round support with the inten-
tion to select from these, five or six councils for longer term support
over a period of two years. The nature of the innovation intentions can
be categorized as follows:

• Service specific (e.g., transport in rural areas, energy security)


• Client specific (e.g., children/young people, adults/the elderly)
Supporting Organizational Innovation in England 19

• Financial modelling (e.g., invest-to-save programs based on early


intervention)
• The re-engagement of communities in local government (e.g., through
social networking)
• Cultural change in the local government workforce as the basis of
establishing innovative councils

An example for each category serves to bring alive the ambitions


pursued through Creative Councils:

• Service specific: Stoke-on-Trent’s goal is to become an energy self-


sufficient ‘Great Working City’ in which a strategic approach to
renewable energy generation and energy security supports sustain-
able economic, social and environmental development. A key driver
for this is the local ceramics industry that plays a critical part in the
local economy of Stoke-on-Trent, comprising a number of successful
international businesses. Energy bills make up a considerable part of
their cost base, and gas bills rose by 55% for some businesses in twelve
months. This project is simultaneously an innovation in strategic bro-
kerage and place-shaping, the processes and approaches being generic
to a range of ways in which local authorities are uniquely placed to
broker across public, private and voluntary sectors – to mobilize user
communities and to innovate with strategic intent across a locality.
• Client specific: Derbyshire wants to change its role as a ‘corporate par-
ent’ so that the support it offers children in care always starts from the
question, ‘If this were my child, what would I do?’ Through Uni-fi, it
will offer a guaranteed entitlement to financial support (sufficient for
the ambitions of the most highly aspiring young people) for children
so that they can pursue self-selected goals, an online platform for
children to store their life stories and mentoring to awaken ambition.
It will also provide social pedagogy training to all staff working with
children in care. Social pedagogy involves practitioners seeing them-
selves as a person in a relationship with the child, with a focus on
the children and staff feeling they inhabit the same ‘life space’, rather
than existing in separate, hierarchical domains. Derbyshire estimates
that this approach will save £29 million over 10 years.
• Financial modelling: Wigan proposes to create a new economic model
for social care in which the councils and its partners meet the serv-
ice and financial challenges (meeting rising needs and expectations
with diminishing funds) by harnessing underutilized and untapped
resources. The approach is five-pronged: First, the introduction of
20 Organizational Innovation in Public Services

personal budgets for adult social care, budgets being topped up by


allocation of ‘Wigan Community Cards’ to kick-start the market;
second, developing the supply side of the social care economy by
supporting micro-enterprises to form and enter the market; third,
developing a set of incentives and rewards designed to stimulate
volunteering within social care; fourth, designing and building a set
of (high tech and low tech) access points to connect supply with
demand; Fifth, establishing a governance system that enables local
people to shape and drive the model as it evolves.
• The re-engagement of communities: Cornwall’s approach is to use open
innovation and new technologies to involve the public in designing
radical solutions to current challenges, simultaneously facilitating
access to a £1 million per annum innovation fund to support new
social enterprises and entrepreneurs. Cornwall’s ‘Shaped by Us’ project
forms the centerpiece of their innovation strategy (Cornwall Council
2012). It is a platform that enables the public to put forward creative
ideas aimed at solving local problems and offers extended mentoring
and financial support to implement the most-promising ideas.
• Cultural change: Monmouthshire’s ‘Your County, Your Way’ aims to
change the culture of the organization to ensure that its services
better meet local needs by closing the gap between the council and
the community. It uses five techniques to do this: First, networked
and agile learning by creating networks of staff to break down tradi-
tional departmental boundaries and generate creative solutions to
local problems; second, systems thinking and doing through a rolling
program of ‘whole systems reviews’ using evidence from engage-
ment with communities so that services are reconfigured in accord-
ance with what matters to them; third, the Intrapreneurship School
that is an internal training program seeking to introduce council
employees to the concept of innovation and what it means for pub-
lic service delivery; fourth, the Go Find, Come Play program based on
global horizon scanning and engagement with other organizational
cultures; fifth, effective listening tools that involve use of open-space
technologies to engage with customers.

The second phase of the program


At the time of writing (2012), the Creative Councils program was mov-
ing into its second phase, with six of the original seventeen councils
selected to receive more intensive support over a further year of the
programme. This second phase builds on some of the strongest ideas
that have the potential to spread to other councils, by providing up to
Supporting Organizational Innovation in England 21

£150,000 in follow-up funding as well as non-financial support such as


legal advice and support with community involvement.
This second phase is intended to promote the UK government’s inten-
tion to re-balance the economy away from centrally run public services
toward an entrepreneurial social and private sector by 2020. The gov-
ernment believes that over one million former public sector employees
(i.e., one in six) could move to newly formed mutual enterprises. For
this to happen, councils need to adopt a leadership role for these ‘dis-
tributed’ services. They may be coproduced with communities in a bot-
tom-up way, the Localism Act 2011 enabling citizens and communities
to gain new powers to take control of public services through ‘double
devolution’.
In this scenario, councils will have to work with communities to
solve future challenges as the guardian, instigator and commissioner of
new service ecologies. However, this will take place against a backdrop
of declining tax revenues and increasing costs creating an urgent need
for local authorities and public sector organizations to find radical new
service configurations (LGA 2012). Nevertheless, the as yet unanswered
question is whether this degree of financial pressure will drive innova-
tion or simply lead to a retrenchment to statutory services (i.e., those
that local governments are required to provide by law) with reduc-
tions in discretionary services (i.e., those that local governments are
not required to provide by law but have been developed by councils
as preventative measures to mitigate social risks, for example, youth
counselling services for long-term unemployed people under the age of
25 years). Hence, spending reductions may be disproportionately con-
centrated on those very services and local governments that have shown
the most will and capacity to be innovative.

Radical efficiency

Some light is shed on the relationship between funding pressure and


innovation by the work from Nesta and the Innovation Unit on Radical
Efficiency (Gillinson et al. 2010; Gillinson and Sissoko 2012). The
Radical Efficiency argument is that if we start with cost-cutting, then we
are almost always tying ourselves into the old system. Asking ‘what can
we lose or give up?’ forces us to trim what we already do. It often fails to
open up new possibilities or new perspectives on the challenge.
Radical Efficiency starts with seeking new perspectives on the
challenge and, in so doing so, seeks to liberate new resources (labor,
knowledge, networks) that enable them to achieve outcomes at much
22 Organizational Innovation in Public Services

lower cost. First, services that are shown to have little or no impact
should be stopped. Second, new resources should be identified and
made available to contribute to a different and more effective solution,
especially the energy and voluntary involvement of service users in
developing new approaches that they believe will work. Third, adopt a
strategy of prevention to identify the core of the challenge in order to
tackle cause instead of symptoms.
The second point (involving service users) and the third point (pre-
vention) have already been discussed earlier. In respect of the first point,
during the expansionary period of real public spending prior to 2010,
innovation generally sought to improve services within their existing
configurations. However, the fiscal contraction now requires emphasis
on reconfiguring services to release resources from low value-added
activities so that they can be used to create greater additionality of social
value. This ‘creative decommissioning’ (Bunt and Leadbeater 2012) is
radically different from the continued interest in service outsourcing,
a third of all services possibly being outsourced by 2014/15 in a bid to
make savings (Interserve 2012).
This continuing emphasis on cost cutting reflects councils’ low capac-
ity to innovate, and so contracting out is likely to increase, at least until
the Creative Councils program is able to identify and articulate the
learning required to be an innovative council – what it takes to gener-
ate the organizational antecedents for innovative practice? And what
approaches will lead to more effective adoption and adaption of inno-
vative approaches in other councils? In effect, this involves developing
tools for innovation that will enable the local government to be in the
driving seat of the changes required by the continuing pressures. For
this to be the case, a series of questions have to be addressed:

• What are the techniques for managing the inevitable risks involved in
innovation – be they financial, political or reputational – particularly
in the context of responsible stewardship of the public purse?
• What levels and types of funding are required to stimulate innova-
tion?
• What forms of evidence are needed to support a judgement to pro-
ceed with innovative proposals?
• What are the specialist skills and tools required to progress an
innovation – financial, scientific, digital, social networking, ethnog-
raphy, or crowdsourcing?
• What are the skills and techniques required for decommissioning
existing services that will be an essential part and consequence of
innovative change?
Supporting Organizational Innovation in England 23

• What are the techniques that will encourage other councils to adopt
and adapt innovations from other organizations leading innovation
when the track record of adoption and adaption is not strong in
public services?

The impact on organizational forms and governance


The decision as to which councils form part of the on-going Creative
Councils program is contingent upon their determination to be part of
a new system of networked learning. This will clearly have implications
for organizational forms, and their governance and emerging themes
include:

1. Developing a new relationship with local people: There is an interesting


debate here as to the balance between the search for a new relation-
ship, with local people being driven by a desire to be more demo-
cratic and by the desire to improve services by unlocking service
users’ contribution to coproduction, or being driven by the wish to
imitate successful private sector companies that seek to better under-
stand their service users so as to be able to design their products
better.
2. Being as inclusive as possible: This requires establishing a balance
between digital and traditional means of inclusion. Many of the
Creative Councils projects have established new levels of digital tech-
nological engagement with citizens and service users. Increasingly,
services are built on a distributed network of resources. This takes
place in the context of a government ambition to make the UK the
best place for superfast broadband in Europe by 2015 – an ambition
that opens up possibilities for a new scale of engagement and inclu-
sion. However, the ‘digital divide’ means that the very creation of new
forms of digital engagement can be excluding – councils are aware of
that and are seeking to ensure that people do not have to be online
to access and influence the emerging shape of council services.
3. Becoming the local broker of local resources and assets: The project in
Stoke is the clearest example of a council becoming the strategic and
coherent mapper and broker of local resources, the better to support
long-term innovation in, and sustainability of, the local economy.
4. Building innovative capacity within the council: Many of the Creative
Councils recognize the need to develop not merely an innovative
approach to the particular service challenge but the broader need
to develop the systemic innovative capacity of the organization as a
whole. This is seen, for example, in the ‘intrapreneurship’ training in
Monmouthshire and in the Social Pedagogy training in Derbyshire.
24 Organizational Innovation in Public Services

5. Introducing new forms of political and managerial leadership: Each of the


themes discussed earlier requires the development of new forms of
political and managerial leadership. The local elected member of the
council is no longer the sole or main conduit of constituency views on
services delivered by the council. Those views will have been expressed
more directly, more rapidly and more constructively by structures and
techniques that seek and value a stronger and more direct engagement
from the citizen and service user – structures and techniques that
attempt to coproduce services with the user. The role of the political
and managerial leadership is to catalyze community ideas to scale
through providing new forms of finance, mentoring and support.

Conclusion: Can barriers to innovation be overcome?

The foregoing discussion of initiatives in England made clear that a


passive approach to innovation is unlikely to be effective: it needs to
be proactive and highly structured but more from the bottom up than
from the top down. Innovation should be embedded within the culture
of the public sector rather than being imposed on it by higher authority
as part of the New Public Management (NPM).
Indeed, NPM-style performance pressures originating from central
government increasingly constrained a more comprehensive approach
to innovation in English local government (and in public services more
generally). A language of innovation was kept alive in local govern-
ment during the era of nationally imposed inspection and audit, but
the extent to which this language reflected embedded practice is ques-
tionable: councils could ‘talk the talk’ but central government’s micro-
management severely limited their ability to ‘walk the walk’ as a result
of its growing cost-based emphasis on improving economy, efficiency
and effectiveness in the use of inputs and processes. Although such
improvements are desirable, they are only a partial approach to innova-
tion, which should be regarded not just as a means of achieving value
for money in promoting economy, efficiency and effectiveness but also
as a means of improving outcome effectiveness of services through
codesign and coproduction.
It has also been made clear that innovation needs resourcing and that
councils need to learn how to innovate. However, cuts as part of the UK’s
ongoing austerity measures result in councils losing the staff they need
to support innovation (e.g., risk managers and those required for coun-
cils to become learning organizations) and cuts in services are leading
to losses in the very front-line staff required to identify and initiate
Supporting Organizational Innovation in England 25

innovation, thereby reducing its scope as a preventative spend-to-save


measure. Hence, it is not clear that the ongoing austerity will in fact
act as a spur to innovation to the extent hoped for by both central and
local government and by politicians, officers and service users. This is
because councils are preoccupied with cutting spending in order to bal-
ance budgets in the next four years or so.
Austerity means that the finance required to overcome the barriers to
innovation identified in the previous discussions will not be available.
Ultimately, rather than being a spur to significantly increased innova-
tion, public sector austerity may turn out to be the biggest of all barriers
blocking it. In that case, scope for innovation may be facilitated much
more effectively if ‘double devolution’ enables and empowers com-
munity organizations, social enterprises and mutual organizations to
become the locus of innovation via mutually owned former local gov-
ernment assets and outsourced services, respectively. Local government
must find ways of ‘catching the wave’ of public service innovation or
risk losing the opportunity to lead the improvement through innova-
tion that its citizens expect.

References
Bunt, L. and Leadbeater, C. (2012). The Art of Exit: In Search of Creative
Decommissioning. London: National Endowment for Science, Technology and
the Arts (Nesta).
Cornwall Council (2012) Shaped By Us: Making Good Ideas Happen. Truro:
Cornwall Council.
DIUS (2008) Innovation Nation (Cm. 7345). London: Department for Innovation,
Universities & Skills.
Gillinson, S., Horne, M. and Baeck, P. (2010) Radical Efficiency: Different,
Better, Lower Cost Public Services. Nesta/Innovation Unit. London: National
Endowment for Science, Technology and the Arts.
The Innovation Unit an Nesta (2012) Getting Ready for Radical Efficiency Guide.
Nesta/Innovation Unit. London: National Endowment for Science, Technology
and the Arts.
Interserve (2012) Local Services: In Need of Transformational Change. www.
interserve.com.
Leadbeater, C. (2006) The Innovation Forum: Beyond Excellence. London: ODPM/
LGA/IDeA.
Leadbeater, C. (2011) Creative Councils: Re-Imagining the Role of Local Government.
London: National Endowment for Science, Technology and the Arts.
LGA (2012) Funding Outlook for Councils from 2010/11 to 2019/20. London: Local
Government Association. www.localgov.co.uk.
Nesta (2008) Social Innovation: New Approaches to Transforming Public Services.
Policy Briefing SI/18 Policy and Research Unit. London: National Endowment
for Science, Technology and the Arts.
26 Organizational Innovation in Public Services

Parker, S. (ed.) (2009) More than Good Ideas: The Power of Innovation in Local
Government. IDeA/Nesta London: National Endowment for Science, Technology
and the Arts.
Parker, S. (2010) Supporting Innovation in Local Government: Lessons Learnt from the
Innovation Catalyst. London: IDeA/Young Foundation/Innovation Unit.
Wilson, R. and Townsend, T. (2011) Catching the Wave: The State of Local Authority
Innovation in the UK and the Creative Councils Programme. London: National
Endowment for Science, Technology and the Arts.
3
Analyzing Organizational
Innovation in Public Services –
Conceptual and Theoretical Issues
Pekka Valkama, Stephen J. Bailey and Ari-Veikko Anttiroiko

Introduction

Chapter 1 provided the rationale for innovation in all sectors of the


economy, specifically to promote economic growth and social devel-
opment. More generally, societies have to be innovative if it is to pro-
tect and promote social well-being within a changing global context.
Innovation in the public sector can both support and be supported by
a cultural predisposition to social innovation, as will be made clear by
subsequent chapters. They focus on organizational innovations that
adopt new organizational forms and introduce changes in organiza-
tional governance relationships.
All organizations have a form in terms of their distinct social and eco-
nomic arrangements. In classic organization studies, the terms ‘functional
organization’, ‘division organization’ and ‘matrix organization’ refer to
basic organizational forms, of which ‘project organizations’, ‘process-
oriented organizations’, ‘partnership organizations’ and ‘network organi-
zations’ are modern variants (Bruzelius and Skärvad 2011, 190–225).
Legal nomenclature refers to ministries, executive bodies, statutory bod-
ies, constitutional bodies, associations, cooperatives, limited companies,
and so on. Managerial terms refer to departments, arms-length bodies,
semiautonomous bodies, third-sector organizations, hybrid organiza-
tions, next step agencies, special purpose vehicles, commercial arms and
social enterprises, even though vague in terms of their legal form or inter-
nal governance structures (Wettenhall 2005; Thynne 2003, 319).
A society’s ability to change can be observed from the diversity of its
organizational forms (Hannan and Freeman 1989). Organizational form
refers to the features of an organization that make it a distinct entity
and, at the same time, identify it as typical of a group of similar types of

27
28 Organizational Innovation in Public Services

organizations (Wood 2009, 931). Organizational form is an archetypal


configuration of structures of human activity that has been given coher-
ence by legal frameworks and underlying ideals regarded as appropriate
within a given institutional context and with regard to particular objec-
tives. Some forms have their origin in the private sector even though
they are used to provide public services – corporations and associations,
for example.
Ultimately, organizational forms are reflections of institutional doc-
trines, but within the context of public services, they also require politi-
cal legitimacy in order to become viable and sustainable (Rao et al. 2000,
242; Greenwood and Suddaby 2006, 30; Tracey et al. 2011, 62).
The adoption of new organizational forms reflects not only develop-
ment of institutional doctrines but also new objectives, transaction
capabilities and ownership rights. There may not be strong incentives
to invest time and resources in order to develop well-considered organi-
zational innovations because they are difficult to protect by property
rights (i.e., patents) and so easy to copy.
As public service delivery systems integrate new organizational forms
(including semiautonomous public bodies and private sector contractor
organizations) to serve citizens and customers and to implement public
policy programs, public authorities and politicians have to re-orientate
themselves to communicate and interact in new ways in order to reflect
the public interest and direct performance to meet needs.

Defining organizational innovation

Organizational innovations are more difficult to identify, observe, and


describe than technical innovations, and they can be shaped by the
subjective interpretations of members of the organization. Hence it is
harder to determine ex ante criteria to define organizational innova-
tions as well as to judge their success. In any case, the purpose of the
development of organizational innovations in public services is to
improve public service system’s responses to contextual changes and to
increase organizations’ internal abilities to renew themselves.
More generally, innovation can be understood as the art of doing
things in a better way than before and so organizational innovation can
be interpreted as an improved way of undertaking given tasks (Nayak
and Ketteringham 1986; Lynn 1997, 86; Altshuler and Zegans 1997, 73).
Organizational innovation is often defined in organizational studies as
the adoption of an idea that is new to the organization (Hage 1999,
597). However, the innovation literature contains several definitions of
Analyzing Organizational Innovation 29

the concept of organizational innovation, which also refers to the crea-


tion of an operational model new to the organization (Lam 2005, 115).
Organizational innovation can therefore also be understood in institu-
tional terms as process, service, administrative or strategic innovation
(Trott 2005, 17).
A more nuanced approach in defining organizational innovation
is in terms of new technical or administrative ideas (Damanpour and
Evan 1984, 392–394). In many cases, technical ideas are new products
or services but sometimes also modifications of an organization’s pro-
duction process or service provision, for example through provision
of online services, new registration methods, new devices and materi-
als, automated service procedures and service integration tools. These
process innovations need to be distinguished from pure technological
innovations because they do not necessarily result solely from the use
of new technology.
Administrative innovations are activated in the social system of an
organization and are modifications or new types of relationships between
people. They include rules, procedures, roles and structures related to
exchange and communication among members of organizations or
between an organization and its environment. Such innovations are not
as readily observable and testable as technical ideas.
Many studies of organizational innovations bypass administrative
innovations, for example formalized strategic planning processes,
management by results, zero-based budgeting, job rotation, internal
coordinating committees, and bonus salary systems (Damanpour and
Evan 1984; Peled 2001, 185). Nevertheless, administrative innovations
may be as important to economic growth and efficiency as are technical
innovations.
Organizational innovation also includes any new technique or divi-
sion of labor at intra-bureau or inter-bureau level, which enables budg-
etary savings to be made or a better adaptation of products to citizens
and customers (Coriat 1995). In this analysis, organizational innova-
tions either substitute for or complement technical innovations. They
can bring quality and efficiency improvements as well as wider social
benefits.
Organizational innovations may be not only new formal organiza-
tional structures but also new management practices and administrative
processes (Alänge et al. 1998, 7). Despite the afore-noted variations in
the definitions of organizational innovation, they all focus on organi-
zational changes that are new and remarkable to the organization in
question.
30 Organizational Innovation in Public Services

Conceptualizing organizational forms of public service

A generic typology of organization of public services


In principal-agent theory, a government is a principal that may employ
either a public or private sector agent to deliver public services. It
was noted in Chapter 1 that the Weberian theory of bureaucracy sees
government as a hierarchically organized apparatus, with public ser-
vice organizations being managed by superior authorities. In contrast
to hierarchies, principal-agent theory sets a contractual relationship
between the principal and the service agent.
A typical way to organize public services is shown under type I in
Figure 3.1, where the government has a command-obey relationship
with the public service agent. In rarer cases (type II), public duties can
also be performed by private agents. Legislators may impose service obli-
gations on private sector actors, for example responsibilities to organize
recycling of waste materials or provision of occupational health care serv-
ices for staff. These cases are examples of type II (Lane 1997, 285–287).
If the government negotiates and makes a contract with a public
agent, it is an example of contracting in (type III), whereas a contractual
relationship with the private agent is contracting out (type IV). Types II,
III and IV can be called alternative or innovative public service deliv-
ery models, which are also associated with the ideas of New Public
Management (NPM).
According to NPM adherents, cost-effectiveness of services can be
improved by promoting a plurality of service providers and by freeing
policy makers to make choices without worrying about the fates of
civil servants who work at public bureaus. NPM is therefore consistent
with the development of enabling government, being based on ‘steer-
ing rather than rowing’ and the purchaser-provider split (Osborne and

Service agent
Public Private

Hierarchical I II
Nature of
relationship
Contractual III IV

Figure 3.1 Generic options for organizing public services


Source: Adapted from Lane 1997, 286.
Analyzing Organizational Innovation 31

Gaebler 1993, 25, 39–40). It promotes devolution of powers and the


localism agenda. These developments are intended to allow govern-
ments to pay more attention to strategic policy-making by avoiding
becoming embroiled in the details of public service administration
(Valkama and Bailey 2001, 55). Together with quasi-market theory (see
Chapter 1), principal-agent theory is a modern and an increasingly
relevant challenge to bureaucratic models of government.

A spectrum of organizational forms for public services


Although four generic organizational arrangements available for public
services are pointed out in Figure 3.1, it does not depict the great variety
of organizational forms within each category. Between the two categories
traditional civil service organizations (i.e., public bureaus) and private
sector limited companies, there are other types of organizational forms
in the public, private and third sectors that may be suitable for public
service purposes (Hood and Schuppert 1990).
Table 3.1 attempts to categorize organizational forms and relation-
ships between principal and service agents. Each cell within the table
includes practical examples of how public services may be arranged
or governed in four sectors: the pure public, para-public, para-private
and pure private sectors. This four-sector categorization avoids use of
the term ‘third sector’. It also avoids resorting to the clichéd conclu-
sion in the literature that the boundary between the public and private
sectors is becoming increasingly blurred. Nevertheless, the examples
in Table 3.1 are fairly conventional organizational forms because this
organizational field is difficult to conceptualize and describe accurately,
as organizational terms and the capabilities of specific forms vary geo-
graphically and over time (Hood and Schuppert 1990).
Pure public sector organizations are stereotypes of public administra-
tion, lacking independence and operating without autonomous legal
capacity. The classic manifestation of the pure public sector is a pub-
lic bureau, also referred to as an agency or office. Higher-level public
bureaus are led by ministers or political bodies, such as committees
or boards, which are held responsible to the cabinet, democratically
elected parliament or municipal council. Lower-level public bureaus are
usually led by politically nominated top civil servants who are respon-
sible to ministerial departments. Some public bureaus with a special or
constitutional status, such as audit offices and central banks, are directly
responsible to legislatures (Greve 2003, 272).
The pure private sector operates on the basis of private law – which
is a crucial element of the market economy – emphasizing private
Table 3.1 Categorizing organizational forms and relationships of public service delivery

Specific organizational forms

Pure public sector Para-public sector Para-private sector Pure private sector

Public Public Government- Registered Social Trust (e.g., Mutual (e.g., Cooperative Private law
bureau enterprise owned limited charity enterprise (e.g., community insurance (e.g., water limited
(e.g., direct (e.g., company (e.g., (e.g., UK community and hospital and leisure) supply) company (e.g.,
in-house energy or trading universities) development trusts) construction
provision) properties) company) company) company)

A classic Public A government- Universities’ Social Some A mutual In rural Legislation


governmental enterprises owned basic enterprises service society may areas may dictate
department have more company funding may have obligations enjoy some cooperatives some but
managed by autonomy is managed comes some service may be set monopoly may take very limited
a command than public and controlled through obligations down in the rights or care of some statutory
and control bureaus, but through the national (for example, statutes of tax reliefs if public service service
system with legally they meetings of funding requirements trusts that it meets (for example, obligations

Hierarchy
detailed are nearly shareholders, bodies by for equal create them certain legal water supply), (for example,
public like classic share capital which treatment) but as arm’s- requirements but such a recycling
budgets. departments supply and universities also economic length or in the service is obligations)
of a public loan terms. have to benefits (for independent production usually closely for private

Nature of governance relationship


authority organize example, tax bodies. of services regulated by companies.
(for example, teaching. reliefs). of general special laws.
waterworks interest.
and
harbors).
A bureau If a public A government- A large Governments Trust Private Cooperatives Private
has to enterprise owned part of may financially hospitals mutuals may may act like companies
participate does not company can universities’ support may have have a right private may bid
in limited have be forced to public some social to compete to challenge enterprises for rights
or quasi monopoly compete for research enterprises for patients and spin in and bid for to produce
competitions power, it public sector funding is to bid for with private by successfully public service services for
in order may have delivery based on public service hospitals. challenging for delivery public
to get to sell its contracts research delivery governmental contracts. authorities
assignments. services through competition contracts. commissions. through
to other competitive (research open

Competition based
departments tendering. proposals / competition.
through applications).
internal
markets.
A bureau A public If a Sometimes A social A community The public Cooperatives A private
which is enterprise government- individual enterprise may interest trust sector may may establish company

Contractual
managed by enjoys owned members or adopt a fee-for- may be able externalize community may get a
objectives monopoly company teams of service model to to enjoy the production partnerships service
and results status, but it is fully academia are produce services public grants, of certain with local contract
based on is managed owned invited to to customers if they public services governments without
negotiated by quasi and controlled work with using vouchers perform to a service or create a competitive

Nature of governance relationship


or dictated contracts. by the governmental with a limited some local mutual. public-private tendering in
quasi government, bodies as operability given development joint venture. special cases
contracts. service experts and by the public services. (for example,
contracts advisers sector. small and

Collaboration based
can be given based on urgent service
to it without reciprocal deliveries).
competitive agreements.
tendering.
34 Organizational Innovation in Public Services

property rights and legal autonomy. The founding principles of the pure
private sector are freedom of contract and contractual commitments.
Limited companies and cooperatives originate from private interests
and generally seek to make profits from which dividends are paid to
their equity-holding owners or return of financial surpluses are given to
the members of cooperatives.
Para-public and para-private sectors have mixed characteristics and
organizations within them have functional features that are atypical
in terms of conventional public law and private law organizations. The
para-public sector is closer to the public than to the private sector, service
organizations being created not only by public authorities (e.g., govern-
ment-owned companies) but also by charities and social enterprises
whose modus operandi is to secure welfare objectives and promote com-
munity interests. Service organizations in the para-public sector have a
distinctive set of property rights separate from public sector property
rights, albeit that the government may be able to modify those rights
by new governance arrangement, including the creation of new legisla-
tion (e.g., giving universities corporate legal status independent of the
public sector).
Many public service organizations have changed their legal status
through agencification to operate as arms-length bodies or ‘quangos’
(that is quasi-autonomous non-governmental organizations) as they
are called in the UK (Veenswijk 2005, 3). Quangos are closer to public
administration than social enterprises because the governing bodies of
the quangos are nominated by public authorities and their activities are
usually supported by public finance.
The para-private sector includes organizations such as trusts and mutu-
als, which have different forms of collectivized (as distinct from private)
property rights. Mutuals are owned by members, and so a majority of
members can choose to privatize their collective property rights, as hap-
pened when some UK building societies (which provided mortgages)
demutualized and became full-fledged banks within the private sector
during the 1990s. Trusts, however, have ‘locked-in’ property rights that
prevent their privatization; examples include heritage and environmen-
tal organizations.
The para-public, para-private and pure private sectors have together
been referred to as ‘third-party government’ in the sense that organiza-
tions operating in these two sectors may carry out some public duties
that are governmentally decided or funded (Greve 2003, 275). This
third-party government has been a growing sector in providing pub-
lic services especially because public bureaus, offices or agencies have
Analyzing Organizational Innovation 35

been transformed toward private-type organizations via agencification.


Additionally, some third-sector organizations have been integrated with
the public service delivery system on their own initiative.
However, the opposite trend seems to be developing today as local
governments in some countries (e.g., the UK and Nordic countries)
are increasingly looking at the third sector to take over some of these
services, whether in response to the public sector austerity or because
municipalities realize that they do not have all the answers to the press-
ing social problems and thus need to engage other stakeholders in creat-
ing value chains (see Chapter 1 and Chapter 2).
New organizational forms can be linked to public services in three
ways. First, changing the legal status of an existing organization through
agencification, corporatization and, in some contexts, mutualization
to replace a public bureau. Second, in rare cases a wholly new organi-
zational form may be developed through the legislative process (e.g., a
community buyout of land or other assets subsequently used to provide
a public service). Third, an existing autonomous organization can be
integrated into the public service delivery system by means of appropri-
ate governance arrangements rather than through organizational trans-
formation (e.g., to provide social care for disabled and elderly people
through commissioning arrangements).
Table 3.1 emphasizes the transition from hierarchical government to
contractual governance, and Figure 3.2 highlights a spectrum of actions
to create more favorable conditions for performance and productivity
improvements by making organizations more flexible through a new
organizational form or the relaxation of organizational rules. Increasing
flexibility of organizational form is depicted in Figure 3.2: The closer
to the center, the more classic the style of public bureaus. Conversely,
the farther from the centre, the more flexible the organizational form.
The increased flexibility of organizational structures and forms can be
exploited to promote achievement of an organization’s strategic pri-
orities, operations and outcomes by developing new and more resilient
models.
Some of what are now classic organizational forms were radically
new when first introduced, and they revolutionized trading models and
economic development. In particular, in the late nineteenth century,
a corporate organization was recognized as a legal entity in its own
right, separate from its investing members. It created the opportunity
for owners to limit their liabilities to the money they invested in the
corporation, rather than being subject to unlimited liability as was
previously the case. Because the members of a limited company are not
Funding
36

Private funding
Ownership rights Handling of annual profits

Rights to buy, sell and pawn properties Triangulated co-payments Given to the organization or its members or owners

Shared between the organization


Limited property rights and the public sector

Tax funding
No property rights Colletivisation

Ordinary Mix of jobs Official positions Political civil servants Professional Business Managers
jobs and positions managers managers

Employment
Legalism No juristic person
Line-item
gross public
Management- budgeting Juristic person under a public law
by-objectives

Management-
by-results Net budgeting Legal person both under public and private law

Legal capacity
Management system
Outside of public budget

Budgeting

Figure 3.2 Key organizational dimensions from a public management perspective


Analyzing Organizational Innovation 37

liable for debts or other obligations of the company, it has been a widely
adopted and successfully applied organizational form in pro-profit busi-
nesses. It has also become a common form in monopoly network indus-
tries, commercial governmental activities and not-for-profit operations
(Davies 2008, 1, 33–37).
This separate legal identity facilitates contracting out public services
to external providers that produce components and other value-adding
or value-creating activities (Lei and Hitt 1995). Offshoring is a par-
ticular form of outsourcing where service production crosses national
borders (Zysman et al. 2011, 42; Borrus et al. 2000; Baldwin and Clark
2000). A very broad definition of outsourcing includes not only all
kinds of subcontracting activities but also hiring of workers on non-
traditional job contracts, such as part-time, temporary and contract
workers (Deavers 1997).1
Recognition that ‘steering’ and ‘rowing’ can be separated was a key
point in the development of outsourcing public services. It became
accepted that the organization of public services does not require them
to be provided by the public authorities’ own organization. However,
outsourcing started to spread first in the private sector and, for some
time, has been one of the fastest-growing business models providing new
markets for service companies and to some extent also for non-profit
service organizations (Fill and Visser 2000, 43; Burnes and Anastasiadis
2003, 355–356). Especially in the early phase of outsourcing, the trans-
formation from in-house production to contract-based production was
mainly about non-core operations (Perry 1997). This picture started to
change during the 1990s as services ranging from security and infra-
structure to health care were outsourced to varying degrees in different
contexts.

From hierarchical control to new public governance

The introduction of new organizational forms in one way or another


into public service systems raises the question of how to arrange rela-
tionships between the new organizations and core elements of the
public sectors such as political bodies, ministerial departments and
other central agencies. Governance by hierarchies is the predominant
model used to rule and manage public bureaus and offices. However,
as the variety of service organizations grows straightforward, top-down
governance becomes increasingly unsuitable.
In the social sciences, ‘governance’ is about creating new forms of
social coordination, whereas in public administration studies, the focus
38 Organizational Innovation in Public Services

is on policy instruments and administrative coordination measures


(Bevir 2010). The new public governance approach acknowledges that
the system of public services is polycentric and includes governmental
organizations, alongside an increasing array of third-party organizations.
Governance of those organizations requires regulation and steering
with the help of modern institutional arrangements such as framework
laws instead of detailed laws, conciliation instead of dictation, and
co-planning instead of arbitrary solutions in the policy-implementation
processes within a multi-sectoral stakeholder context to pursue the col-
lective interest and public good (Anttiroiko et al. 2011, 3). The ultimate
function of the new public governance is both to direct and to enable
public policy stakeholders to operate in ways preferred by society.
In public administration, bureaucratic control practices focus on pro-
cedural responsibilities and compliance with rules, public budgets and
centralized standards, but the new public governance is more interested
in performance accountability. Government as a principal gives duties,
resources and defined freedom to public service agents, that are then
answerable to the principal that monitors performances of the agents
by requiring result reports from the agents. The principal may also use
penalties and rewards related to achievement of results defined in con-
tracts and in the terms of public subsidies. In public bureaus, clear roles
and hierarchies make it easier to identify officers who are responsible,
but as service delivery systems become increasingly polycentric, identi-
fication of who is accountable becomes more challenging (Bevir 2009,
33–35; Jobome 2006, 43–44; Goldsmith and Eggers 2004, 122–123; Yang
2012, 257).

External and internal governance mechanisms


In the polycentric environment, governments try to steer stakeholders
of public services and keep them accountable by means of a multifunc-
tional set of internal and external governance mechanisms. A diverse
set of governance mechanisms is needed to support good governance,
including not only accountability but also the principles of fairness,
transparency and neutrality (Bevir 2009, 92–96; Munshi 2004, 51, 52;
Hyndman and McDonnell 2009, 7). However, the impossibility theorem
of good governance is that law makers and public authorities have to pri-
oritize some principles over the others (Bovaird and Löffler 2009, 11).
Table 3.2 illustrates internal and external governance by using a
charity sector example. Although boundaries between them may blur,
external mechanisms are designed to be arms-length whereas internal
Analyzing Organizational Innovation 39

Table 3.2 Internal and external governance mechanisms in charity sector

I Internal governance II External governance


mechanisms mechanisms

1. Approval of the internal 1. Law and by-laws


governing documents
2. Traditional trustee boards 2. Approval of the founding documents
3. Separation of chair of trustee 3. Reporting requirements
board from chief executive
4. Traditional board committees 4. Funding-based obligations
a) Executive committee
b) Investment committee
c) Trading and/or fundraising
committee
5. Other traditional governance 5. Donor interest and scrutiny
mechanisms
a) The restriction of fund use
by donors
b) The role of members in
information provision
c) Internal audit
d) Internal supervision
6. Business-type corporate 6. Contractual and commissioning
governance codes requirements
a) Audit committee 7. Concessions in specific fields of
b) Remuneration committee economic activity
c) Nomination committee
8. Regulatory supervision
9. Nomination and suspension of trust
members
10. External pressures (from customers,
media and general public)

Source: Adapted from Jobome (2006, 46).

mechanisms are the responsibility of the stakeholder organization itself


( Jobome 2006, 45).
External governance is carried out not only by public authorities
such as regulatory bodies, funding bodies and legislature but also by
the media and private donors. Legislation provides a basic legal frame-
work concerning the nature, boundaries and capabilities all kinds of
stakeholder organizations, but there are also many other mechanisms
that act as tools especially for policy-making authorities to specify
40 Organizational Innovation in Public Services

and contextualize their wishes. Financial accountability is particularly


important when a government is subsidizing third-sector organizations
through grants and allowances, and it is realized typically through
reporting and auditing requirements ( Jobome 2006, 44).
Internal governance is carried out by stakeholder organizations them-
selves, and the perennial concern is accountability because many conflicts
of interest easily arise between boards, executive officers and employees.
The adoption of corporate governance codes and the practices of internal
audit and supervision are examples of internal governance mechanisms
( Jobome 2006, 43–44).

Contractual accountability
The most prominent feature of new public governance is contractualiza-
tion as governments downsize public sectors by transferring governmental
functions to third-party contractors (Campbell 2007; Vincent-Jones 2007;
Sulle 2010). Contractualization creates opportunities to break organiza-
tional boundaries and extend the outreach of public measures by enabling
the public authorities to acquire and comanage external resources and
expertise. Governments also seem to want to relax bureaucratic control
within public administration through internal contractualization via
quasi-contracts with public bureaus (e.g., service level agreements).
In contract governance, ex ante accountability methods are used
before a contract has been signed and can be competition or collabo-
ration (see Table 3.1). Ex ante methods include external organizations
tendering (i.e., bidding) competitively for public procurement contracts
and auctions of concessions and internal competition (also known as
‘yardstick competition’) where public service producers are managed by
results based on performance measurement and benchmarking (Savas
1987; Revelli and Tovmo 2007). However, some empirical studies have
demonstrated that a competitive environment does not necessarily make
contractors more accountable (Romzek and Johnston 2005, 436–437).
Contracting based on competitive tendering is usually open to a wide
group of potential bidders. The alternative is to use a collaborative con-
tracting model restricted to selected candidates. Collaboration means
that the contractor is selected and the contract is designed through
negotiations. Although public procurement rules generally restrict col-
laborative arrangements (e.g., the EU’s), collaborative contracts may
range from fairly informal and short-term contracts to long-term and
highly structured forms of cooperative contracting as alliances, partner-
ships and joint ventures (McQuaid 2000, 11; May and Winter 2007,
480; Harris 2010, 28–29).
Analyzing Organizational Innovation 41

Competition and cooperation are not necessarily mutually exclu-


sive mechanisms to build and maintain the relationship between the
governmental principal and the public service agent. In the case of
outsourcing services, for example, contracting out is usually begun by a
process of competitive bidding, but after the contract has been signed
the parties have to cooperate as contract partners until the next round
of competitive bidding. Moreover, some forms of cooperative arrange-
ments include elements of informal or hidden competition such as
requiring comparative grounds for contract payments.
The management of the modern service supply chain (i.e., network)
needs to be more and more innovative in arranging coexistence of these
dynamic forces and to rotate the elements of competition and cooperation
in a continuum of many contractual relationships, one after another.
Ex ante accountability measures refer to contractual supervision as
contracts are always incomplete and agreed under conditions of uncer-
tainty, which causes problems relating to information scarcity, adverse
selection and moral hazard. Supervision may be mainly through cus-
tomers choosing between alternative service providers within a quasi-
market of publicly funded services where contractors have to compete
for customers. Otherwise, public authorities have to act like principals,
holding contractors accountable for their performance through meas-
uring outcomes and supervising possible contract violations concern-
ing agreed inputs, processes and outputs (Bevir 2009, 35; Romzek and
Johnston 2005, 437).

Dialogic accountability
Bureaucratic control is based on low trust between policy functions and
administrative functions, where, without strict surveillance, the self-
interest of public employees would jeopardize rule of law and budgetary
discipline. Principal-agent theory demonstrates that all-inclusive con-
trol is not cost-effective as agency costs arise from monitoring an agent.
Hence, the accountability approach has gained predominant position
within new public governance (Fama and Jensen 1983, 304–305).
Agency theory tries to identify governance relationships that can
accommodate conflicting aims between the parties to an assignment
and tries to construe an optimal incentive system with which the
principal can control the agent. However, agency theory is similar to
bureaucratic theory as both see the agent in a pessimistic light as a self-
interested slacker (Eisenhardt 1989).
There has been much research in administrative science concerning
techniques that public authorities could use to keep agents accountable
42 Organizational Innovation in Public Services

and to improve those accountability techniques. Collaborative govern-


ance challenges the typical accountability methods described earlier,
by introducing a model of dialog between the parties. The assumption
underpinning this dialogic accountability and collaborative governance
is based on humanistic and cognitive conceptions of contract parties
seen as constructive and more equal participants (Yang 2012, 257).
Collaborative governance has theoretical foundations in stewardship
theory, which bypasses individualistic and opportunistic behavior mod-
els by assuming that more cooperative and altruistic attitudes prevail and
holds that the principal and agent have commonality rather than con-
flict of interests. If new public governance applies stewardship theory, it
results in a more relaxed attitude concerning possible agent deceptions,
frauds, excessive management rewards and other such issues because the
agent is not opportunistic (Clarke 2004, 4–9; Davis et al. 1997). Hence, a
higher level of trust can be built between the contract parties as the agent
is intrinsically motivated toward collective service and understands that
its success depends on how satisfied politicians and public authorities are
with its performance, communication and responsiveness.

Conclusions

It has been made clear that organizational innovation involves new forms
of accountability, there having been a clear development over time in the
forms of governance. Direct hierarchical control became increasingly
complemented by economic governance through markets for procure-
ment and use of public services and then by collaborative stewardship
arrangements utilizing dialogic accountability.
This development makes clear that organizational innovation in
public sectors involves much more than just the restructuring of
organizational form. This may be the case in the private sector where
unbundling and outsourcing service components is driven by cost con-
siderations and profits potential as outlined in Chapter 1. In the public
sector, however, organizational innovation is driven by a broader set of
objectives, not only financial considerations but also outcome effective-
ness via engagement of and collaboration with a wider set of stakehold-
ers. Economic governance has to therefore run in parallel with dialogic
accountability and social governance.
These governance foundations of organizational innovations are illus-
trated in the following chapters as they consider outsourcing, agencifi-
cation, corporatization, mutualization, social enterprises, joint ventures
and so on. They demonstrate that the success of such innovations in
Analyzing Organizational Innovation 43

organizational form is crucially dependent upon simultaneous innova-


tions in the ways in which service providers are held accountable for
the quality of services they provide. The changing ways in which they
are made accountable are reflected in the change from government to
governance.

Notes
1. There are many innovative derivatives of outsourcing and related neolog-
isms. These derivatives include smartsourcing (a novel concept developed
in response to problems of outsourcing), crowdsourcing (outsourcing to an
undefined group of people usually in the form of an open call), co-sourcing
(expert functions such as audit that are performed in concert with a client’s
existing internal arrangements) and self-sourcing (the use and empowerment
of own staff to develop service systems and related technologies).

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Part II
The Process of Organizational
Innovations
4
Agencification Processes
and Agency Governance:
Organizational Innovation
at a Global Scale?
Koen Verhoest

Introduction

During the last two decades the structuring and functioning of the public
sector has undergone major shifts from a centralized and consolidated
public sector to a decentralized, structurally devolved and ‘autonomizing’
public sector, including the disconnection of policy design, implementa-
tion and evaluation (OECD 2002; Pollitt and Bouckaert 2011; Christensen
and Lægreid 2006). Systems of public administration have been disaggre-
gated into a multitude of different kinds of (semi-)autonomous organi-
zations, denoted as ‘agencies’ or ‘quangos’ (Flinders and Smith 1999;
Pollitt and Talbot 2004). This disaggregation through ‘agencification’ is
the result of a process of vertical and horizontal specialization, based on
geography as well as different types of purposes, tasks, customer groups
or processes (Christensen et al. 2007; Roness 2007). In this process of
agencification and autonomization, the responsibilities and autonomy of
public organizations are redefined (structural aspect). Moreover, the way
in which they are controlled by government, including the mechanisms
of accountability, is redesigned – mostly from ex ante to ex post, and from
input-based to result-based rationales (functional aspect).

Agencies as innovative organizational form?

An ‘agency’ is an organization that is structurally disaggregated from


the government or from units within core ministries and operates under
more business-like conditions than the government bureaucracy (Talbot
2004; Pollitt et al. 2004; Van Thiel 2012; Verhoest et al. 2010). Agencies
can have a different financial system and personnel policies, although

49
50 Organizational Innovation in Public Services

the degrees of financial, personnel, and management autonomy vary by


(type of ) organization. Basically, they have some capacity for autono-
mous decision-making with regard to management or policy. Compared
with government bureaucracy, agencies face less hierarchical and politi-
cal influence on their daily operations. Therefore, semiautonomous
agencies operate at an arm’s length of the government. But they are
still formally under at least some control of ministers and ministries
that encompass more than just control as shareholder or market regula-
tor. Furthermore, these bodies are mandated to carry out public tasks
including regulation, service delivery and policy implementation. Last
but not least, they have some resources of their own and have some
expectation of continuity over time, making them distinct from purely
temporary (advisory) committees, interdepartmental teams, task forces
and tribunals of inquiry.
A recent 30-country comparison came up with a threefold typology,
based on the formal-legal features of these organizations (Van Thiel
2012; Verhoest et al. 2012; see also OECD 2002). The type closest to
the core government (Type 1 agencies) are departmental agencies,
which are semiautonomous structurally disaggregated organizations,
units or bodies without legal independence but with some managerial
autonomy. Well-known examples are the Next Steps Agencies in the UK,
contract/executive agencies in the Netherlands and the ‘agenzia’ in Italy
or the ‘direct’ agencies in Germany (see Van Thiel 2012; Ongaro 2009;
Bach and Jann 2010). Type 2-agencies are legally independent organiza-
tions and bodies (based on statutes) with managerial autonomy, mainly
based on public law. The ‘public establishments’ in Italy, Portugal and
Belgium; the Zelfstandige Bestuursorganen in the Netherlands and the
non-departmental public bodies in the UK; and statutory bodies in
Australia and Ireland belong to that category (Wettenhall 2005). A last
type (Type 3 agencies), which is less straightforward, refers to private
law-based agencies established by or on behalf of the government like
a foundation or corporation, company or enterprise, in which the gov-
ernment owns the majority or all ownership shares. Examples are com-
mercial companies, state-owned companies (SOC) or enterprises (SOE)
and government foundations.
Agencies as organizational form, as defined earlier, were already in
existence in most countries much earlier than the era of New Public
Management (NPM) (Greve et al. 1999; Schick 2002; Wettenhall 2005).
This old-style agencification had some common features in terms of
governance that can hardly be called innovative. Most of these forms
were still strongly governed by rather detailed regulations: ex ante and
Agencification Processes and Agency Governance 51

input-oriented control instruments, and politicized forms of control, mak-


ing their enlarged autonomy very relative in nature.
However, what is innovative is the way the NPM doctrine and related
reforms changed the motives and the ideal-type governance of agen-
cies. An NPM-based ideal-type agency model and governance associated
with all kinds of merits was strongly propagated from 1985 onward
originally by Anglo-American governments and international organiza-
tions, including the OECD, the World Bank and IMF. This propagation
sparked a proliferation of agencies across the globe ( James 2003; Pollitt
et al. 2001). Basically, NPM-doctrines envisaged making governments
‘lean and mean’ by trying to make public sector organization func-
tion as private sector for-profit companies and incentivizing them by
(quasi) market-like pressures (Bouckaert 1997). Therefore, public service
delivery organizations had to be disaggregated from their parent depart-
ments, in small and lean ‘single-purpose’ bodies with a maximum of
managerial autonomy. The enlarged managerial decision-making com-
petences allowed agency managers to react swiftly to changing environ-
ments and demands of service users.
Central to the NPM ideal-type of agency is that the relation between
the government (parent department) and the individual agency is gov-
erned by a performance contract, which is negotiated between the two
actors. This performance contract, as a form of ex post result-oriented
control, was supposed to set out clear and challenging performance
targets, which are then monitored and evaluated by the parent depart-
ment and to which (non-)achievement is financially rewarded (or sanc-
tioned). Moreover, wherever possible these agencies should be facing
(quasi or real) competition (Horn 1995; Walsh 1995). Very different
from the old-style agencification was the structural split between policy
development, steering and evaluation on the one hand and policy
implementation and service delivery on the other hand, the former
tasks being undertaken by parent departments and the latter by the
semiautonomous bodies. So, NPM-style agencification is not just about
organizational decoupling, but also a ‘decoupling’ in the policy cycle.
This split, and the entire concept of NPM-style agencies, was based
on principal-agent theory, in which lack of trust by the principal in the
implementing agent is central and strong performance-based control
and incentives are needed to avoid opportunistic behavior by the agent.
Central to this NPM-doctrine on agencification was the belief that such
agencies would be superior compared with traditional public organiza-
tions in result-oriented and customer-oriented innovative behavior as
well as their efficiency and the quality of their services (OECD 1994;
52 Organizational Innovation in Public Services

OECD 1997). Its impact on structures of government globally was


impressive, with policy implementation tasks being taken out of the
core departments and structurally hived off (Verhoest et al. 2012).
However, since somewhat more than a decade, the initial enthusiasm
about the NPM-style agencification has been tempered significantly.
Post-NPM, initiatives under the umbrella of ‘Post-NPM’, ‘whole of gov-
ernment’ and ‘post-crisis reforms’ have problematized the fragmenta-
tion of the state and the loss of transparency, that has been brought
about by NPM reforms. These are said to have resulted in a proliferation
of highly detached and different bodies, a lack of coordination and
collaboration within the public sector and a loss of economies of scale
because of a multiplication of management support functions (like
personnel or financial administration) (Christensen and Lægreid 2008).
It has been strongly argued that although NPM-led agencification may
have had benefits at the level of individual organizations and its service
delivery, it has caused a loss of control and coordination at the level of
policy domains and the whole government (Bouckaert et al. 2010).
Since 1995, many OECD countries have rationalized their agencies,
for example in Germany, the Central and East European countries, UK
and Ireland (Verhoest et al. 2012) or, more rarely, fully reintegrated in
their parent departments (MacCarthaigh 2010). Trust, shared objectives,
common cultures and frequent interaction between these bodies are
strongly emphasized, even by once hard-core NPM-advocates (OECD
2008). Reconnecting policy development and implementation has been
another new element. Hence, agency governance has again been rein-
vented to a large extent.

Agencification as transformative process

In the old-style pre-NPM agencification, motives for agencification were


linked to the creation of ‘checks and balances’, co-steering by societal
interest groups in neo-corporatist societies (like the tripartite control
of social security agencies in Belgium by government and the social
partners), reducing political risks and securing persistent implemen-
tation of new policies under changing political coalitions by putting
them sufficiently far away from government (Moe 1995; Horn 1995;
Yesilkagit and Christensen 2010). Also, other motives such as enabling
direct political control through politicization of the top management
functions or keeping specific expenses out of governmental budgets
were paramount in this era of agencification. NPM-style agencification
is mainly motivated by the quest of increased specialization, efficiency,
Agencification Processes and Agency Governance 53

service innovation and responsiveness to customers, as noted earlier.


The post-NPM approach to (de-) agencification is motivated by the
need to deal with ‘wicked’ societal challenges (climate change, internal
security, poverty, etc.) and the limitations of a fragmented public sector
to handle cross-cutting contested problems.
Most countries went about their agencification processes in a pre-
dominantly ad hoc and unsystematic way, creating their own agencies
without any kind of blueprint, without a thorough ex ante evaluation
of available forms, without fixed criteria and without similar tasks being
given to similar types of agencies (Van Thiel 2008; Eerste Kamer der
Staten-Generaal 2012).
Hence, in most countries, there is no clear relation between task char-
acteristics and the chosen organizational form. The design of effective
control and accountability arrangements was generally given much less
attention than discussion about the autonomy and managerial flexibil-
ity of agencies (OECD 2002).
So what are the different steps or critical building blocks in the agenci-
fication process? A first element is what to agencify; what kind of public
task is to be hived off? Logically, agencifying service delivery versus
regulatory tasks has different consequences for autonomy and control
arrangements. The choice whether or not to give agencies a role in policy
development and advice is crucial. Moreover, although agencies are gen-
erally believed to be single-purpose bodies, this is mainly the case with
NPM-style agencification. Pre- and post-NPM agencification is much
more comfortable with the creation of multipurpose agencies, combining
different tasks and objectives, because of economies of scope, synergies
and coordination benefits. Also, there is the choice of the legal form. Giving
an agency legal independence vested in public (or even private) law has
a significant impact upon its managerial autonomy – its top governance
structures and especially upon the formal mechanisms that the political
and administrative principals have in order to control the agency and to
call it to account. Moreover, the legal autonomy of an agency influences
the ease with which the decisions of an agency and its status can be over-
ruled by political decisions of its minister (Verhoest et al. 2004).
A third set of decisions are related to the extent of decision-making
autonomy that the agency should have in terms of its primary processes
(policy autonomy) and in terms of management (managerial autonomy
regarding HRM, financial management and organization manage-
ment). There is also the issue of financial autonomy, being the extent
of self-funding compared with funding through the state budget. Here,
autonomy is multidimensional and many different combinations of
54 Organizational Innovation in Public Services

policy autonomy and (different dimensions of ) managerial autonomy


exist. Service delivery agencies mostly have high levels of managerial
autonomy, but almost no policy autonomy.
On the other hand, one can find inspection agencies with a high
level of policy autonomy but almost no managerial autonomy, as they
are still part of the parent department. However, the autonomy granted
to an agency on one dimension may in the day-to-day practice of this
agency become less functional if autonomy in other dimensions is lack-
ing. In this perspective, the overall autonomy of an agency is actually a
product of balancing managerial, policy, financial and legal autonomy
in such a way that it has a positive impact on agency performance, that
is, policy implementation, service delivery, regulation and execution of
public tasks (Lægreid and Verhoest 2010).
There are differences between the formal autonomy as stated in the
legal basis of an agency and the actual degrees of freedom of an agency
(Yesilkagit and Van Thiel 2008; Verhoest 2002). Moreover, some agencies
make more use of their autonomy than others even if they belong to
the same (legal) category and have the same levels of formal autonomy
(for example, see Verschuere 2009). Senior managers in agencies use
strategic behavior and build reputations to strengthen their autonomy
(Carpenter 2001) or to be very close to politicians. Formal rules and
regulations, which seemed functional when the agencies were created,
become obsolete after a while or are not enforced as they were intended
to be. Hence, when designing agencies with specific formal degrees of
autonomy and control arrangements, politicians and senior administra-
tors need to bear in mind that formal design and its actual functioning
are two different realities (Verhoest and Lægreid 2010; Van Thiel 2012).
Granting extended levels of autonomy to agencies should be counter-
balanced by clear mechanisms for steering and control by the principal
(minister and/or parent department) of the agencies. Choosing the
appropriate steering and control mechanisms is another set of decisions
to be taken, when agencifying services. Like with autonomy, ministers
and parent ministries have several ways to control the agencies under
their remit. Hence, when political and administrative executives design
control arrangements for agencies, there is always a choice to be made in
how to combine ex ante control (oriented toward inputs and procedures)
with ex post result-oriented control (contract management), structural
forms of control (through the appointment and evaluation of agency
managers and board members) and control through formal and informal
contacts between principals and agencies. One kind of control can
strengthen and complement other forms of control or contradict and
Agencification Processes and Agency Governance 55

weaken them. Moreover, although agencification does normally attenu-


ate political steering signals compared to core departments (Egeberg
and Trondal 2009), political control does not always respect the formal
logic of the organizational form. Where agencies perform tasks with
high political salience, or of a high budgetary weight, de facto political
control may be much stronger than originally envisaged by the designers
(Pollitt et al. 2004; Van Thiel 2012).
The steering and control of agencies requires new skills and com-
petencies of parent ministries. There is no longer a direct and purely
hierarchical relationship. Because agencies are (semi-) autonomous, the
relationship has become more horizontal and objectified. This means
that the traditional, purely hierarchical instruments for steering and
control will be less appropriate. Also, the NPM ideal-type agency-model
stresses that control of public organizations should shift from the use of
traditional ex ante and input-oriented controls (e.g., extensive regula-
tions, requirements for prior approval, legality and compliance-oriented
oversight) to more ‘hard’ ex post and result-oriented control mechanisms,
in order to combine managerial flexibility with responsibility for results.
Performance contracting is one way to organize the steering relationship
between parent ministries and agencies in a more horizontal, transpar-
ent way and to direct the agency toward its results within clear financial
boundaries (Jann et al. 2008; McGauran et al. 2005; Verhoest 2005).
The way performance indicators and norms are used as elements in the
control relationship is crucial. When it comes to the contractualization
of the control relationship, political principals can choose between a
‘hard’ contracting and a soft ‘relational’ contracting approach (Verhoest
2005). The latter form of contracting brings in trust as an important
instrument to streamline and structure the relationship between the
government and the agency. There are however other complementary
instruments to make horizontal relations between the principals and
their agencies, like account management through liaison officers in the
UK, interface units in the Netherlands, coordination platforms, com-
mon information exchange platforms and so on. There is a wide menu
to choose from when political and administrative principals design
the kind and intensity of interaction and relation they want with their
agencies (Van Thiel and Yesilkagit 2011). Structural control through the
appointment and evaluation of agency managers and board members
by the government has long been considered as a powerful way to con-
trol agencies.
A last set of decisions is about how governments design the coordination
arrangements to keep their landscape of agencies transparent and effective
56 Organizational Innovation in Public Services

in dealing with interorganizational issues. Related to this is the changing


relationship with stakeholders (other than government) and with users
of agencies’ services. Service users are empowered in the NPM and post-
NPM approach to agencification in their role as ‘customers’ to be satisfied
(NPM), as codesigners involved in shaping the strategic direction of agen-
cies and as members of horizontal accountability forums (post-NPM).
As transformative process, agencification seeks to change not only the
relations between the government and an agency but also the agency
itself and the way it acts. There is considerable evidence that newly cre-
ated autonomous agencies emphasize cultural features that distinguish
themselves from the parent departments from which they originate
(Veenswijk and Hakvoort 2002). Van Thiel (2008) has referred to this
process of differentiation between newly created agencies and their
parent departments as the human process of adolescence in which ado-
lescents distance themselves from the values of their parents in order to
shape and assert their individuality. As ministerial departments are still
more infused with traditional cultures emphasizing compliance, details
and precision, newly created agencies will emphasize organizational
cultures that are sufficiently different: based on customer orientation,
flexibility, innovation, and risk-taking behavior (Van Thiel and Van der
Wal 2010; de Bruijn and Dicke 2006; Van der Wal and Huberts 2008).
Egeberg and Trondal (2009) show that agency managers are less receptive
to political steering signals than are departments and that agency manag-
ers are more oriented toward the needs of their target group. However, the
question remains whether or not this difference in organizational culture
will have a straightforward effect on the internal management and gov-
ernance of agencies, on the way they change and innovate their working
processes and procedures and on their performance. Agency managers can
make opposite decisions in terms of centralization and formalization of
their internal organization, even when they are in agencies with similar
formal legal status and degrees of autonomy (Verhoest 2002).

Transforming agency governance

Hierarchical governance, market-like governance (based on princi-


pal-agent theories) and network-like governance (based on relational
contracting, stewardship and trust theories) reflect the (optimal) way
agencies were (envisaged to be) governed in the pre-NPM, NPM and post-
NPM periods, respectively (Thompson et al. 1991; Kaufmann et al. 1986).
Table 4.1 details how these three general mechanisms for social life inter-
action manifest themselves regarding the governance of agencies.
Table 4.1 Three agency governance models and their critical building blocks

Governance model 1: Governance model 2: Governance model 3:


The hierarchy-based The market-based The network-based governance
governance approach governance approach approach

Basic general features of this governance mechanism


Base of interaction Authority and dominance Exchange and competition Cooperation and solidarity
Basic mechanisms Top-down norms and Offer and demand, price Shared values, common problem
for steering and standards, routines, mechanism, self-interest, profit analyses, consensus, loyalty,
control supervision, inspection, and losses as evaluation, courts; reciprocity, trust, informal
intervention invisible hand evaluation – reputation
Role of Top-down rule-maker and Creator and guardian of markets; Network enabler, network
government steering, dependent actors purchaser of goods; actors are manager and network participant
are controlled by rules independent
Theoretical basis Weberian bureaucracy Neo-institutional economics Network theory, stewardship
(principal-agent theory) theory
Application to agency governance
Period Pre-NPM agencification NPM-style agencification Post-NPM agencification
Central vision • A highly integrated public • A highly autonomized public • A strongly interconnected,
sector, with agencification sector oriented toward core tasks moderately varied public sector
in ad hoc, exceptional and • Horizontalization of relations as part of a wider organizational
rare cases; relations are still between units based on ‘hard’ field (e.g., other levels of
quite hierarchical contracting and government, NGO’s).
purchaser-provider split

(continued)
57
Table 4.1 Continued
58

Governance model 1: Governance model 2: Governance model 3:


The hierarchy-based The market-based The network-based governance
governance approach governance approach approach

• Central focus is on • Central focus on performance • Horizontalization of main


compliance to top-down and efficiency improvement of relationships based on relational
detailed orders, rules and individual units ‘soft’ contracts and trust
regulation • Incentives and competition as • Central focus is on joining up
• Obedience and threat drivers for performance the actions of different actors in
of sanctions for order to attain effectiveness in
noncompliance overall political objectives and
as drivers for performance user-oriented services, shared
values and norms, and
coordination
• Public sector motivation,
mission and cooperation as
drivers for performance
Tasks to be • No split between policy • Full split between policy design • No split between policy design and
agencified design and implementation (parent departments) and implementation (departments
(agencies and departments implementation (agencies), and agencies work closely
have mixed tasks) needed because of distrust together in policy design and
• Multipurpose large agencies in agency and because of implementation, each from their
(besides single-purpose principals’ dominant position own specialization; departments
agencies) in contract negotiations tend to move toward a mainly
• Single-purpose small-sized coordinating function)
agencies • Multipurpose large agencies
(because of mergers and
economies of scope) besides
single-purpose small agencies
Autonomy of • Relatively low levels of • High levels of managerial • Moderate levels of managerial
agencies managerial autonomy autonomy autonomy
• Relatively high levels of • Low levels of policy autonomy • Moderate levels of policy
policy autonomy • Irrespective of task autonomy
• Irrespective of task • Strongly linked to the task
Ex ante versus • Dominance of ex ante • Ex post result control through • Mix with long-term ‘relational’
ex post control input- and process-oriented short-term ‘hard’ performance contracts
control mechanisms contracts • Through limited set of general
• Through detailed rules and • Through detailed performance indicators, mutual monitoring
regulations, prior approval targets, frequent monitoring through frequent interaction
requirements, veto right and audits, explicit and and close collaboration
of agency decisions by quasi-automatic performance- • No automatic, financial
government, ‘commissaires based sanctions in sanctions; external pressure
du gouvernement’ case of malperformance based on collaborative links
• External pressure through and mutual expectations in
(quasi-) competition in networks
quasi-markets and benchmarking
Use of • Performance indicators • Vast set of strict, detailed • Limited set of performance
performance rarely used performance indicators used as indicators, used as basis for
indicators • If used, mainly ‘hard’ performance targets in communication, mutual learning
process-based indicators, order to constrain agencies and joint strategy setting
which are unilaterally in their policy implementation • Focused on general outputs,
set by principal discretion (policy autonomy) effects, collaboration between
• Compliance with rules and • Focused on detailed outputs, organizations and cross-cutting
regulations is main basis for efficiency and quality objectives
sanctioning • Norm-setting through negotiation, • Mutually agreed indicators
but dominated by principal • Only one element for
• Strict basis for quasi-automatic coordination and joint initiatives
sanctioning
59

(continued)
Table 4.1 Continued
60

Governance model 1: Governance model 2: Governance model 3:


The hierarchy-based The market-based The network-based governance
governance approach governance approach approach

Interaction • Informal politicized contacts • Business-like, formalized relations • Combination of formal and
and relation • Frequent interactions • Interaction limited to contractually informal personalized contacts
management through process-based stipulated moments • Frequent interaction in order
between steering • Frequency of interaction kept low to foster collaboration, shared
principals in order to maintain objectivity in values
and agencies ‘hard’ contracting • Congruent organizational
• Fostering of different cultures by rotation and
organizational cultures in exchange of personnel
departments and agencies
• Mainly based on lack of trust
between partners
Top • Agency management • Agency management and board • Agency management and
governance and board members in members competitively selected board members are selected
structures position through political based on merit; no mutual based on corporate governance
appointments membership between boards principles, and mutual
• Governing boards with • Governing boards have only memberships for personal
strong government limited government representation linkages between organizations
representation and in order to avoid steering problems • Governing board as forum to
government control agents; in a contractualized relation. involve service users, experts and
governing boards as forums Independent board members have other stakeholders in the joint
for political control very important role. control of agencies and as form
of horizontal accountability
Coordination • Coordination mainly • Coordination mainly through • Coordination through
of agencies through vertical mechanisms, market-like mechanisms like network-like mechanisms like
such as task allocation, contracting and competition interface functions, coordination
detailed planning and • ‘Spontaneous’ horizontal platforms, joint decision
instructions from the coordination between agencies making bodies, joint planning
principal to different through competition and and budgets, intense information
agencies benchmarking exchange and shared services
• Little horizontal • Horizontal coordination between
coordination and interaction agencies is deliberately
between agencies stimulated in order to deal with
cross-cutting wicked problems
Involvement • Involvement mainly limited • Strong involvement of services • Involvement of broad,
of stakeholders to corporatist representation users at the operational level, pluralistic set of stakeholders
of main strongly organized which are seen as customers; (users, peers, regulators, interest
interest groups in governing customer satisfaction is crucial groups) at the strategic level,
boards of agencies criteria for performance; direct and through horizontal
• No involvement of influence by interest groups is accountability mechanisms (like
service users avoided user panels; advisory committees;
• Vertical accountability is visitations; certification)
enriched with feedback • Horizontal accountability
information from customers relations in a multi-tie
accountability web

Source: Adapted from Bouckaert et al. 2010.


61
62 Organizational Innovation in Public Services

Hierarchy-based governance of agencies


In this model agencies are seen almost as a variant of the traditional
Weberian bureaucracy, albeit with more autonomy. The creation of
structurally separate agencies is still rather exceptional. The behavior
of agencies is strongly regulated ex ante or subject to prior approval
and veto rights by the parent departments and political principals. As a
consequence, both management and policy autonomy of the agencies
is restricted. Goals, target groups and policy instruments are defined by
statute and ministerial orders, but within that the parent departments
and ministers have the maximum flexibility to give the agency instruc-
tions with which the agency has to comply. The activities of the agen-
cies have to be approved by minister and department through highly
detailed business plans. The agency reports extensively on its activities.
Evaluation and audits focus mainly on the compliance of the agency to
relevant rules, regulations and ministerial instructions.
Governing boards, which are appointed autonomously by the min-
ister, are populated mainly by representatives of government and by
representatives of a strictly limited set of interest groups (i.e., corporat-
ism). The board has a supervisory role and may intervene in operational
matters impacting upon the interest of the minister and government.
The agency management is appointed, controlled and dismissed by
the minister, mostly based on political affiliation criteria. The depart-
ment is the main supervisor of the agency and is highly involved in
ex ante regulation and detailed monitoring of the agencies’ activities.
The activities of multiple agencies are coordinated mainly by rules and
instructions (see Table 4.1).
This model of agencification with its ex ante input-oriented control
was most explicitly present in the Napoleonic and Germanic countries
(the ‘tutelle’ of public law agencies) and it still exists (Verhoest et al.
2012). In Sweden, agencies were mainly under input control before
the NPM-reforms started. Nevertheless, the research has shown that in
many countries ex ante and input-oriented forms of steering and control
are still dominant and often used (e.g., in Estonia and Lithuania) and
through functional oversight (in Germany), at least formally.
Moreover, some aspects of recent agency reform programs seem to
refer to the hierarchy-based model. Examples are: the review of the
status of agencies and the ad hoc reintegration or merger of a limited
number of agencies in Ireland, New Zealand and the UK; the creation
of super-departments in Australia and USA (the Homeland Security
Department in the USA case); the preference for departmental forms of
agencies over legally autonomous agencies with their own board in the
Agencification Processes and Agency Governance 63

Netherlands and Flanders; and the reduction in financial management


autonomy of agencies in several countries.
However, these measures are mainly intended to decrease the pro-
liferation of agencies and to regulate their policy autonomy, but cer-
tainly not to the extreme extent that the Hierarchy-based Governance
approach would advocate. Even in countries that adopt such measures,
governments refrain from restricting the management autonomy of
agencies too much.

Market-based governance of agencies


In this model, a proliferation of many small-sized single-purpose agencies
is not considered to be a problem as long as these agencies are embedded
in well-functioning markets in order to incentivize them and coordinate
their activities. This governance model advocates the strict separation
of policy-implementation and policy design, by splitting the purchaser
role (to be performed by the departments) and the provider role (to be
performed by the agencies). The relationship between the departments
and the agencies is contractualized with very detailed output norms and
strict sanctions laid down in hard short-term contracts. Ideally, there are
multiple providers, so departments let agencies compete with respect to
the prices of their products, their quality and quantity. Moreover because
of the competition, departments have substantial information to com-
pare the economy and efficiency of agencies. The focus of the whole
system is mainly on the improvement of performance and efficiency of
individual units, rather than the effectiveness of government policy.
In order to give agencies the flexibility necessary to compete, their
autonomy in respect of HR and financial management is maximized
within some minimal common restrictions. Their financial account-
ability is based on performance budgets, accrual and analytical account-
ing systems with price calculation, and on performance audits. Policy
autonomy is limited at the strategic level, with the objectives as well
as detailed and demanding targets laid down in the detailed perform-
ance contracts between department and agencies. There are extended
and detailed reporting mechanisms in place, which are solely based on
quantitative indicators of quality and efficiency. The department as a
purchaser evaluates the execution of the performance contract through
very extensive and formal procedures, and underperformance results in
financial sanctions or the ending of the contract. The overall relation-
ship between department and agency is formal and business oriented,
and mutual contacts happen only around formal moments of contract
management (i.e., negotiation, interim monitoring and evaluation).
64 Organizational Innovation in Public Services

Departments are well-equipped for the development of objectives and


targets, for contract formulation, monitoring and evaluation.
Boards are not considered as agents of the minister or government,
but they focus solely on the interest of the agency, and its members are
selected mainly for their management capacities through open compe-
tition procedures based on job description. The board focuses on the
strategy of the agency and appoints controls and dismisses the CEO as
thought necessary.
In this approach, the government relies fully on (a) the contracts
between purchasers and providers, (b) competition and (c) the interplay
of offer and demand for the coordination of the different actors within
and outside the public sector.
This market-based model can be considered as a purified version
of the NPM-style agencification (OECD 1994; 1997). Because of the
emphasis on contracts between purchasers and providers, it has poten-
tial to clarify accountabilities. Financial incentives and competition
may stimulate agencies for increased performance. And by its focus on
accrual accounting and performance-based financial management, it
feeds information about the relative efficiency of agencies into deci-
sion-making. This scenario is an extreme expression of the model of
governance of agencies, which was pursued by New Zealand and the
UK in the 1980s and the first half of the 1990s. However, a major draw-
back of this model experienced in both the countries is the excessive
emphasis on the objectives and targets of individual agencies to the det-
riment of cross-agency or ‘whole of government’ objectives (Bouckaert
et al. 2010). Moreover the stress on competition and incentives that are
oriented to individual agencies inhibits cooperative relationships with
parent departments and between agencies themselves.
The associated heavy and detailed monitoring and evaluation arrange-
ments proved to be very expensive and inhibited trust building. In the
case of New Zealand, the hard performance agreements and purchase
agreements have even stimulated a risk-averse attitude of CEOs who
develop a checklist mentality by strictly sticking to what is stipulated in
the contract, instead of an entrepreneurial attitude (Gregory 2003). Ex
post and results-based steering, encompassing the formulation of result
objectives and targets, the monitoring and evaluation of these targets,
with result-based sanctions, is still not fully developed in many coun-
tries (but the UK and most Nordic countries are exceptions, although in
the latter sanctions are not really applied). However, even in countries
with well-developed systems of result control (like Sweden and the UK),
problems are reported about too detailed, too inflexible and too many
Agencification Processes and Agency Governance 65

targets – sometimes with perverse effects – or a lack of evaluation and


benchmarking of results. Since the second half of the 1990s, countries
as the UK and New Zealand tried to overcome the deficiencies of the
pure market-based governance approach by attenuating some aspects
and by complementing them with aspects of the network-based govern-
ance approach.

Network-based governance of agencies


The network-based model emphasizes a strongly interconnected public
sector, rather than an integrated or atomized one. In such a public sec-
tor, different types of agencies exist as part of a wider organizational field
(including NGO’s, public-private partnerships, and citizen groups) with
which the government can cooperate in order to achieve its objectives.
The central focus is on joining up the actions of the different actors in
order to attain overall policy objectives and user-oriented services, based
on shared values and norms. Effectiveness of policy is crucial.
In such a setting, agencies can be multipurpose and also have a role
in policy design, with their input to the parent department coming
together with the policy input of a whole range of societal actors. There
is a ‘clustered variety’ with respect to the management that autonomy
agencies have, again depending on the task and the type of agency. With
respect to HR, autonomy is constrained by a limited set of common regu-
lations that ensure mobility of personnel between organizations.
HR policy is considered an important instrument to create shared
norms, values and ethos throughout the public sector. Therefore agen-
cies are geared toward the creation of a corporate management culture
within the public sector. The policy autonomy of the agencies is rather
large, with their objectives and targets being negotiated within broad
departmental-level objectives. In this process, relevant actors (such as
users, interest groups and other agencies) are consulted. Strategic plans
at the level of the agencies are explicitly linked to the strategic plans at
the level of the departments, at the level of the cabinet and at the level
of other relevant agencies.
The partnership between agency and department is laid down in
a long-term ‘relational’ contract (linked to the strategic plan of the
agency), which set out the mutual obligations and flexible procedures
for interaction. A limited set of quantitative and qualitative high-level
indicators, some of which are focused on cross-agency collaboration, are
used as tool for frequent coordination and contacts. The emphasis is on
self-monitoring and evaluation by the agencies, with external audits only
being used to check the reliability of self-evaluation. Such an evaluation
66 Organizational Innovation in Public Services

involves departments, user groups, and other agencies and stakeholders.


Reporting mechanisms are ‘light’ and integrate both financial and per-
formance information. In frequent meetings, the partners discuss the
performance progress, finances and matters of policy.
Departments and agencies are seen as interdependent partners each
with their own specialization and with shared responsibility to achieve
government objectives. Agencies and departments (and other relevant
actors) have coordination mechanisms in order to jointly monitor pol-
icy design and implementation. Intensive formal and informal contacts
are maintained and coordinated. The department has a crucial role in
strategically controlling, overviewing and monitoring the whole policy
field, including the agencies, in order to assess and improve cooperation
and coordination for the effectiveness of policy.
Boards of agencies have an important role in coordination and sharing
of responsibility. Therefore the parent department as well as related pub-
lic organizations and relevant societal actors are represented. Selection
of board members is predominantly based on the need for involvement
of and accountability to societal actors, which bring in the necessary
expertise regarding management and policy.
This scenario acknowledges the complexity of government structures
and cross-cutting ‘wicked’ policy issues. It calls for a strategic overview
by minister and department of this organizational field in order to get
policy implemented effectively. Coordination between all involved
actors in a specific policy field is crucial and is enhanced by intensive
networking on all levels, coordination, chain management, exchange
of information and mobility and training of personnel. The governance
of agencies fits in this scheme and is more broadly oriented than just
checking if the agency has fulfilled its contract ‘to the letter’ or if it has
complied to the relevant rules and regulations. Potential drawbacks are
that the efficiency of individual agencies might be of less interest than
the overall effects of agencification. Also, there is a huge cost involved
in all these coordination efforts, which might not be quite equaled by
the gains in terms of policy effectiveness.
This model reflects, to a large extent, elements of the emerging
post-NPM reforms in some countries, for example in Scandinavia, the
Netherlands, France and recently in Belgium (e.g., Flanders). Moreover,
since the second half of the 1990s, NPM-adhering countries like New
Zealand and the UK also bring in aspects of this approach by introduc-
ing systems of strategic management and networks, by ‘joining-up
programs’. In Sweden, the Netherlands and the UK, performance con-
tracts are increasingly seen as instruments to improve communication,
Agencification Processes and Agency Governance 67

exchange, negotiation and mutual learning between parent ministries


and agencies, rather than harsh performance contracting regimes
with extensive indicators and sanctions (e.g., in Norway there are no
sanctions).

Conclusion

Agencies as organizational form have existed for a long time and so


are hardly innovative. What is innovative is how, under the influence
of NPM doctrines and later post-NPM doctrines, governments have
reinvented and reframed the governance of agency by fundamentally
altering the critical building blocks of the agencification process. Each
governance model has its advantages and drawbacks, and elements of
all three models are to be found in the agencification practice in OECD
countries. This hybridity might cause tensions but has merits in that
the respective drawbacks of the individual governance models are held
in check.
The NPM ideal-type agency model with high levels of managerial
autonomy, result control and private sector-style internal manage-
ment enhances the performance and innovative behavior of public
sector organizations. However, research into agency performance is
scarce and the empirical evidence of such effects is still inconclusive
(Verhoest and Lægreid 2010; Lægreid et al. 2011). Nevertheless, there
is evidence that under specific conditions, increased autonomy and
result control leads to more innovative behavior or an increased
use of result-oriented management tools within agencies (Verhoest
et al. 2010; Wynen and Verhoest 2012), which could be considered
as preconditions for better performance. There are many different
factors that play an important role. Agencies’ innovative behavior
is stimulated by their organizational culture (i.e., orientation toward
goals, customers and individual incentives), by the quality of manage-
ment, by organizational factors like size (staff and budget), kind of task
(service delivery) and possibilities for collaboration with other organi-
zations, including the parent ministry (Lægreid et al. 2011; Koch and
Hauknes 2005; Martinaitis and Nakrošis 2009). In addition, external
pressure from competitors or from the media and political attention,
may also boost innovativeness, but may also have negative side effects.
Additional factors include the clarity of goals, political support and
the degree of self-financing by agencies (Verhoest and Lægreid 2010).
Governments can stimulate innovation and thus performance by cre-
ating such conditions.
68 Organizational Innovation in Public Services

Hence, agencification as transformative process does not necessarily


lead to more innovation within public sector organizations. It strongly
depends on the governance model deployed.

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5
Corporatization as Organizational
Innovation
Pekka Valkama

Introduction

There is good reason to interpret corporatization as an organizational


innovation in public services. Corporatized units have become very
extensively applied organizational changes in public services during
the past 20–25 years (McDonald and Ruiters 2012, 4; Bilodeau et al.
2007; Valkama 2002, 90). This is indeed a radical change as it intro-
duces the principles of private sector organizational characteristics
into the sphere of public service responsibilities. Corporatization has
proven to be an essential part of governments’ means to not only
reorganize conventional public enterprises but also manage new types
of public responsibilities. Airports, car parking services, postal services,
railways, telecom, gas and water supply are classic governmental enter-
prises that have been corporatized. Examples of new objects of service
corporatization are museums, motorways, pilotage services, hospitals,
universities, information and communication technology services and
governmental real properties (Herzog 2011; Yamamoto 2004; Harding
and Preker 2000).
Not only in Western and OECD countries but also in transition econo-
mies and communist countries, many governmental agencies, depart-
ments and enterprises have been transformed through corporatization.
It is not easy to point out which countries were among the first to
introduce this innovation, because governmentally owned or chartered
commercial corporations have had a long history. In past decades, state-
owned companies were established directly as corporations but the era
of corporatization refers to a type of organizational innovation that is
transforming governmental bureaus into private sector organizations.
The wave of corporatization in the governments of New Zealand and

72
Corporatization as Organizational Innovation 73

Australia in the late 1980s attracted a lot of an attention, and the organi-
zational changes implemented in those countries have greatly inspired
governmental reformers in the countries with a modernization agenda.
More recently, debt crisis and austerities measures may encourage
West-European countries to promote corporatization. The UK coalition
government is considering corporatization of the Highways Agency and
the Greek government has published a reform program including aims
to corporatize regional airports and ports (Glaister 2010, 62; Hellenic
Republic, Ministry of Finance 2011, 21).
The first aim of this study is to conceptualize corporatization from
the perspective of public service delivery systems. Given that corporati-
zation is a somewhat tricky and vague term and that the public sector
management literature includes different definitions (Everett and Pettitt
2006, 222), this study endeavors to bring conceptual clarity to the mat-
ter. The conceptualization of corporatization constitutes foundations to
elaborate different objects of corporatization and types of corporations.
The second aim is to model the process of corporatization and explain
the critical phases of the process. These analyses will produce two dif-
ferent process models that can be understood as abstract descriptions
which help to build up an understanding of the management chal-
lenges in the process of corporatization.
Corporatization can be analyzed as a legal or administrative transac-
tion, but this study attempts to combine these two approaches. Corpora-
tization can also be seen as a private sector, third sector or public
sector innovation, but the idea here is to show how this organizational
innovation lowers and transcends classic boundaries between the three
sectors.
The key methodological problem of conceptual studies of the inno-
vative use of alternative organizational forms is due to differences in
legal frameworks in different countries. The applications and transla-
tions of organizational terms may at times be confusing, as the same
concepts may be used to refer to different organizational variants. This
chapter analyses the use of the concept of corporatization as an abstract
tool without specific contextual relations other than some European
perspectives.

Theoretical underpinnings of corporatization

According to public choice theory, public services are expensive and


inefficient because public bureaus enjoy a monopoly status and policy
makers are not able to evaluate budget proposals made by public
74 Organizational Innovation in Public Services

managers and control public spending of public authorities. This is one


part of the classic agency problem, arising because the policy makers
as principals do not have the same information as the public bureaus
about the real costs of inputs necessary for service production. Niskanen
(1971) made these assumptions more specific by building the budget-
maximizing model claiming that bureaucrats try to maximize the agen-
cy’s budgets and resources for their own career purposes, salaries and
other job benefits. The first assumption of public choice theory is that
a large number of production units is needed to create competition or
that markets are highly contestable if there are a few production units.
Second, the production units need sufficient autonomy to be able to
adapt service processes to technical developments, the changing needs
of customers and varying financial resources. Without these conditions
public bureaus operate in a formalistic way framed by administrative
law, and public services systems remain expensive and unresponsive
(Boyne 1996, 703–704; Scott 1996, 12–13).
Although some critics have claimed that public choice theory includes
some normative elements (Salminen 1986; Anttiroiko 1994; Boyne 1996,
703–704), it has been quite objective in indicating the incentive prob-
lems of public policymaking. However, other than competitive auton-
omy, public choice theory provides no practical suggestions on how to
implement those improvements. In contrast, quasi-market theory was
developed as a constructive theory and was able to demonstrate how
to introduce competition into public service systems. In order to create
a competitive service market, governments should split governmental
functions into service purchaser and service provider functions and
create planned markets between them. Service purchasers represent the
collective needs of local communities and compare production options
objectively by focusing on the needs of local residents. The service pro-
ducers, in turn, can focus on making production efficient and managing
service capacity (Le Grand and Bartlett 1994, 2–10; Bailey 1993, 148;
Meerabeau 2001; Bailey 2002, 150; Powell 2003, 726, 729).
Quasi-market theory underpins the new public management (NPM)
that can be understood as a set of axioms within public sector manage-
ment doctrine. NPM promotes value for money by creating the condi-
tions for performance improvements in public service systems. On the
one hand, NPM emphasizes the importance of managerial work and
concludes that public sector managers should be allowed to manage and
that the public sector should adopt management styles from the private
sector. On the other hand, NPM has been concerned with how to create
organizational prerequisites for the applications of quasi-markets and
Corporatization as Organizational Innovation 75

the mechanisms of competition. Semi-autonomous organizational sta-


tus is seen as the minimum requirement for competitive quasi-markets.
Nevertheless, it is not only a question of organizational competence but
also of organizational functions. Government departments and bureaus
have been multipurpose organizations with policy, planning, produc-
tion, supervision and regulation functions. According to NPM, these
multitasking public service organizations are not sustainable in a com-
petitive environment and they have to be replaced by more focused and
specialized organizations. Public bureaus are role oriented hierarchical
organizations but flatter, more flexible and more businesslike organi-
zational arrangements are required for quasi-market-type conditions
(Hansen 2011, 285–288; Bilodeau et al. 2007, 120).
According to Bevir (2009, 127), marketization is a process including
the introduction of competition and pricing mechanisms into public
services, and it is generally believed that these mechanisms generate
‘creative destruction’ by eliminating inefficient service providers and
enabling the growth of innovative providers (Landy and Levin 2007, 3).
In order to make the purchaser-provider split clear-cut, simplify decision-
making, establish better conditions for management incentives and
create credible conditions for trading relations; some governments have
considered it best for service providers to be totally separated from their
service purchasers and so have increased their independence through
corporatization.1
However, supporters of theories of bureaucracy, of the public inter-
est and of the welfare state may deny the benefits of corporatization
by arguing that it will undermine public values, cause an erosion of
democratic control, weaken rights of access principles, prevent cross-
subsidization and replace long-term objectives by short term incentives
(Chavez 2012, 477; Valkama 2004, 131).

Defining corporatization as a process

The definitions of corporatization can be classified into two groups.


The definitions of the first group focus on the renewal of the economic
and technical features of a service delivery system and the evolution of
the roles and compositions of the service system actors. For example,
according to Sumsion (2006, 100–101), corporatization refers to a rapid
expansion of privately owned or operated enterprises in a service deliv-
ery system. She studied nursery services in Australia where in the early
1990s childcare was dominated by not-for-profit organizations. Since
then private and profit-making corporations have captured a significant
76 Organizational Innovation in Public Services

market share in childcare services. Bazzoli (2004, 885–886) studied the


corporatization of American hospitals and concluded that corporatiza-
tion refers to a process where autonomous, not-for-profit and local hos-
pitals are transformed into centralized, networked and for-profit hospital
corporations. Braithwaite et al. (2011, 135) said that if corporatization
is defined in a simple way it refers to a governmental reform that allo-
cates more financial responsibilities to semi-governmental agencies and
that promotes the application of competent business practices. Authors
(Steck 2003, 74; Neumann and Guthrie 2002, 722–727; Robertson
2010, 191, 199), who studied the corporatization of higher education,
concluded that corporatization means that higher education institu-
tions adopt such decision and funding criteria, management processes,
organizational cultures, remuneration and penalty practices, measurable
and tradable targets and branding and marketing strategies that have
their origins in national or international business corporations. These
features reflect impressions and evaluations of changes made inevitable
by globalization and commercialization of education markets.
According to Shirley (1999, 115), corporatization refers to efforts to
make governmental service organizations operate more effectively by a
regulatory change or the introduction of more competition by remov-
ing entry barriers and cutting down public subsidies so as to make the
markets for public services contestable and give the same powers and
incentives to public managers as exist in private business corporations.
In summary, this first group of definitions of corporatization refers
to changes in the organizational landscape that create the corporate
model in place of departments, agencies and third sector organizations
and the associated changes in the regulatory framework that emphasize
performance evaluations, workable market conditions and safeguarding
the public interest in place of the supervision of legal, budgetary and
public code matters.
The second group of definitions of corporatization takes a narrower
view of corporatization as an organizational transformation process or
a specific legal change of organizational form. According to Fidler et al.
(2007), corporatization relocates a governmental unit from public
administration by incorporating the agency to an organizational form
of private law enterprise with the government as the sole shareholder
in the new company. Zhan (2008) takes the view that corporatization is
an ownership restructuring measure whereby a government surrenders
direct control of a public enterprise by delegating decision-making pow-
ers to the managers of the enterprise, allowing the managers to make fully
independent decisions. Smith (2004, 380) argues that corporatization is
Corporatization as Organizational Innovation 77

a process of constructing an arm’s-length service unit that is owned


and operated by the government but that is made both managerially
and financially semiautonomous. Briathwaite et al. (2011, 135) adopt a
specific meaning of corporatization to refer to an incorporation accom-
plished by a government. In that process, a new legal entity (that is
a corporation) is created and a defined set of independent rights and
binding obligations is given to the new organization.
It is possible to summarize the second group of definitions of corpo-
ratization as referring to the abandonment of the governmental form
of an organization and the introduction of the form of a corporation.
Corporatization implies a set of administrative actions that convert a
non-independent public sector entity into a legal person in the nature
of an enterprise with a corporate style capacity to have competence that
is separated from the owners of the company. For example, a corpora-
tion is a legal person with its own properties and debts. Additionally, on
the one hand, the owners are not liable for its debt obligations, but on
the other hand, the owners cannot directly monopolize its properties
(Davies 2008, 33, 37).
A common misconception is that the object of the act of corporatiza-
tion is a state enterprise or municipal enterprise. Both public enterprises
and state-owned businesses have been possibly the most common
targets of corporatization policies but, to be conceptually precise, the
object of corporatization may be all kinds of governmental owned enti-
ties and administered units. The object does not only have to be a well-
established department. In some cases, a specific public operation entity
or an exclusive item of public sector property can be corporatized.
In other cases, the classic sphere of the public sector is not the origin
of the object of corporatization. First, the object may already have a
special autonomous status as an external public law body of the public
sector. For example, due to agencification it may be a body under public
law or a public law foundation. In the British context, such bodies are
called quasi-autonomous non-governmental organizations (these are
quangos). Such public service organizations have a legal personality,
but they are not enterprises, even though they may practice some sem-
icommercial activities. Secondly, the origin of the object of corporatiza-
tion may already exist under private law. Associations and private law
foundations are good examples of these types of organizations that are
seldom used by state governments but more often by municipalities. For
example, in many countries, municipalities run regional and national
associations that have a purpose to produce specific services for the
local government sector.
78 Organizational Innovation in Public Services

Alternative types of corporations and companies

Corporations and companies can be categorized in different ways. In the


European Union, member state companies are categorized into private
and public companies. Public companies are more heavily regulated
because they collect equity capital by issuing shares to the general pub-
lic and professional investors through the stock market. Because private
companies cannot issue shares and bonds to be traded in the proper
stock market, they are suitable as small businesses (Airaksinen et al.
2007, 10; French et al. 2007, 193).
In British company law studies, companies are categorized into regis-
tered companies, statutory companies and chartered companies. A huge
majority of companies are registered companies that are registered and
operated under company law. Statutory companies are usually entitled
to some monopoly rights and are very uncommon as they are created
only by a special act of a parliament that is a very old method of incor-
poration. Chartered companies are established by means of a royal char-
ter, but the number of such companies is minimal since royal charter
is used mainly for higher education institutions, academies and artistic
and learned societies (Davies 1997, 5–6; Davies 2008, 21–22).
Those corporations that do not issue shares are non-stock corpora-
tions, such as charities and mutual insurance companies. They are
sometimes also referred to as ‘companies limited by guarantee’. In being
created without share capital, they are not suitable for profit making
and sharing purposes. Most companies are limited to liability for share
capital, and that is where working capital is contributed by their owners
(Davies 1997, 10–12).
From the perspectives of public administration studies, the most typical
types of government-owned companies are public-service corporations,
which usually are not full-fledged business-type trading corporations.
Public-service corporations are public-benefit companies such as railways,
telecommunications, gambling, banking, port administration, electric-
ity, and water corporations. Those public-service corporations typically
experience limited competition, but their operations are characterized
by widespread social benefits and sensitive national interests, and so
they are strictly regulated. Public-service corporations may make profits
and share them with the government-owner, but profiteering is gener-
ally not allowed. Hence, in some monopoly industries, the regulatory
framework may cap the prices of commodities in order to restrict
the rate of return to a publicly acceptable level. Some public-service
corporations may also operate some non-commercial activities or
Corporatization as Organizational Innovation 79

take care of certain community service obligations (Bozec and Breton


2003, 32).
The second type of government-owned companies comprises non-
profit companies. It is a common misconception that all companies
have a profit motive – it is only an assumption of company law. The
owner of a company may specify some charitable or other not-for-profit
purpose for the company and prohibit the distribution of profits to
shareholders by defining these characteristics in the articles of associa-
tion (i.e., corporate by-laws).
The third specific group of public sector corporations consists of cooper-
ative corporations (Garner 2004, 365–368). Cooperative corporations are
legally similar to any other corporation as their purpose is usually to pro-
duce local services or to manage assets. For example, housing and property
management corporations established by municipalities may operate as
cooperatives. The fundamental idea of a cooperative corporation is not to
pursue financial surpluses in its accounts. Nevertheless, the corporation
may give dividends to its owners if it happens to make profits.

Two models of the process of corporatization

It is possible to model and phase the process of corporatization in many


ways based on circumstances such as whether the process is carried out
in the central or local government sector and whether it is a statutory or
voluntary process for a public authority. In this analysis, a holistic model
of corporatization is developed based on the broad conception of corpo-
ratization. First, it refers to changes in the organizational landscape of
public services as it creates the corporate model in place of departments,
public bureaus and agencies. Second, it refers to the abandonment of
the hierarchical powers of command and the introduction of competi-
tive quasi-markets with the practices of contracting in and out. Third,
the broad conception of corporatization refers to the changes in the
aims and forms of regulation. Rather than deregulate, a government has
to reregulate the whole institutional framework – starting with the legal
rules, setting policies for the regulatory authorities and finishing with
wider fiscal policies (Landy and Levin 2007, 5; Vogel 2007, 27).
Subsequently, a more formal model of the process of corporatization
will be constructed based the narrow conception of corporatization. The
formal model includes not only some legal requirements that have to be
applied in the process but also some policy issues that are meaningful in
terms of what considerations are necessary in order to formulate good
preconditions for a successful public sector corporate ownership policy.
80 Organizational Innovation in Public Services

The holistic model


The holistic model of the process of corporatization presented in Figure
5.1 includes not only the most common changes of organizational
form within the public sector but also continuums after corporatization
(i.e., incorporation). The starting point of the holistic model is a public
bureau. It is governed by a politicized management board or senior civil
servants, strict line-item budgeting and specific administrative rules and
regulations. In the model, the process of corporatization includes many
steps reflecting gradual autonomization of the public bureau ending
with the form of a limited company. The limited company may be the
final outcome of the process in some cases, but Figure 5.1 also presents
four options that may follow after corporatization.
The first phases numbered 1 to 4 in Figure 5.1 in the holistic proc-
ess are not actual changes in the legal form of the organization but are
transitions to new administrative forms of the public bureau within
the public sector. In phase 1, the system of hierarchical management
is complemented by quasi-contractual practices and in this way a new
organizational type is created internally and referred to as the contract
department. The contract department or ‘the contract agency’ not
only follows hierarchical orders but also negotiates with the ministe-
rial department, resolves some matters with ministers and executes
measures agreed on (Greve 2003, 270). Nevertheless, as these kinds
of contract parties are not equal, the new system can be called quasi-
contracting. In phase 2, the gross budgeting system of the contract
department is replaced by net budgeting. Both expenditure and revenue
items are fixed in classic public sector gross budgeting. In contrast, the
net budgeting department enjoys budgetary flexibilities and the manag-
ers of the department can decide whether to balance the finances of the
department by adjusting the expenditures or revenues or both, consist-
ent with their net budget allocated by the competent authority.
To reveal any cross-subsidies in monopoly industries and to control
the market operations of the departments with a dominant market posi-
tion, it may be necessary to separate such departments from the public
sector bookkeeping system by creating a balance sheet department
(phase 3). Balance sheet departments usually operate under the public
budget, but they have their own profit and loss accounts and balance
sheets to increase transparency and openness (Myllyntaus 2001).
Phase 4 in the holistic model includes the introduction of the organi-
zational form of public or municipal enterprise. A public enterprise
is legally a governmental department, but in contrast to ordinary
governmental bureaus, the public enterprise can be described as an
G: Re-regulation Legalization of F:
of an industry private sector status Reassessment of
6a.
governmental
Privatization
6b. subsidies
Joint venturing Limited Public-public
6c. company organizational
Public-public autonomization
partnership 5d.
company 6d.
Joint public
E: Introduction of
Insourcing: departmentalization body
quasi-market

1. 5c.
Contract
department

Contractualization
Public bureau, i.e.
2. classic department Body under
public law Legal
Net personalization
budgeting 5a.
department 5b.

by results
Balance sheet Public
department enterprise

A: Introduction
D: Introduction of a

of management
3. regulatory body
4.

Increasing
budgeting
flexibilities Increasing latitude
of managers

B: Introduction of
C: Introduction of
performance
competition supervision
budgeting and audit Increasing
financial
transparency
81

Figure 5.1 The holistic process model of corporatization


82 Organizational Innovation in Public Services

arm’s-length body as it enjoys wider autonomy than ordinary depart-


ments. Even though they may enjoy a dominant market position, public
enterprises usually have to sell their services, and so they need to have
sufficient administrative flexibility to enable them to cope with fluc-
tuations in the prices of raw materials and also in demand. The second
argument is that public enterprises practice routine business transac-
tions relatively often, and so there is not the same need for strict politi-
cal supervision and official solutions as there is in other governmental
bureaus. For example, ordinary departments have to adhere to central-
ized public budgets and observe human resource management policies
whereas public enterprises may operate without the same restrictions.
Instead a long-term rate of return on capital employed, requirement
may be imposed on investments by the public enterprise.
Often, the public enterprise is incorporated directly into the form of
a limited company in phase 5a without going through phases 5b–d.
A public enterprise is usually part of the public sector and so lacks full
autonomy. Nonetheless, the body under public law has a legal identity
in accordance with the principles of public law. This means that it is
fully authorized to make contracts on its own behalf, to sue and be sued
and have limited property rights. Joint public bodies are public-public
partnership organizations with full rights of public law and legal per-
sonality. Joint municipal boards and municipal district organizations are
examples of such organizations at the regional or subregional levels.
Phases 5a and 5d are the core transactions in the process on the way
to an independent company. They finally separate the public depart-
ment or body from the parent organization of the public administration
and the management practices of the public sector. At least this is what
is supposed to happen when the private sector position and the status of
private law legal personality is granted to the newly incorporated unit
(Thynne 2003, 324). In practice, because there are hardly any changes in
staff, the renewal of the organizational culture and the adoption of busi-
ness leadership may be a long process for the company. Additionally,
due to its public sector ownership, the limited company has to comply
with certain public sector rules and regulations. For example, publicly
owned limited companies usually have to adhere to the obligations of
public procurement law.
After incorporation, Figure 5.1 presents four possible mutually exclu-
sive development scenarios depicted by phases 6a to 6d. Many corporati-
zation processes have ended in a privatization transaction implemented
by a stock exchange listing, transfer of ownership to members of the
public by privatization vouchers, or a sale of the shares of the company
Corporatization as Organizational Innovation 83

by an equity trading transaction (phase 6a) (Graham 2003; Mickiewicz


and Baltowski 2003, 417). If the governmental limited company is only
partially privatized, this arrangement can be called a public-private joint
venture company (phase 6b). Where one public authority shares the
ownership of the limited company with one or more public authori-
ties, the new creation may be called a public-public partnership joint
venture company (phase 6c). The last option (phase 6d) is to insource
the limited company back into the public administration by departmen-
talization and assimilation. This is not just a theoretical option; incor-
porated units have sometimes failed as limited companies or the public
owner has not been satisfied, and the owner has reversed the process of
corporatization.
Alongside the changes of organizational form, the new competition
policies and the regulatory framework are gradually drafted and imple-
mented (Greve 2003, 275). The outer circle of Figure 5.1 includes repre-
sentation of regulatory and marketization changes typically associated
with the holistic process of corporatization (from A to G). The introduc-
tion of a quasi-market for public services requires very detailed regulation
as the target groups of many modern welfare services include children,
elderly people and other vulnerable groups. Furthermore, it is important
to manage many kinds of system risks of public services as they sustain
many basic functions of modern societies, such as public infrastructure
and information systems. Depending on the specific service industry,
evolution of the regulatory framework may be manifold, but regulatory
changes generally require independent regulatory agencies as the state
divests itself of hierarchical and interventionist control systems.
Attempts have been made to replace binding laws (with their supervi-
sion and sanctions) by soft laws complemented by new incentive struc-
tures and benchmarking arrangements and new governmental advisory,
information sharing and adjudicatory functions. Direct governmental
interventions are endeavored to decrease whereas co-regulatory and
self-regulatory arrangements are assigned a major role in the era of the
developing network economy of public services (Hardiman and Scott,
2010; Saurwein 2011).

The formal model


The formal model of the process of corporatization is based on all the
necessary actions of an incorporation made by the public sector summa-
rized here into four main phases (Statens offentliga utredningar 2010, 63)
relevant from the point of view of what choices significantly affect the
possibilities for the governance of publicly owned corporations.
84 Organizational Innovation in Public Services

The first phase is the decision-making process of corporatization. It


is first and foremost a process of political negotiations and bargaining.
Proper administrative preparations for incorporation cannot be initi-
ated before its political approval, but sometimes such political prepa-
rations may include difficult overtures, campaigns, compromises and
trade-offs, and it may take many years before a political majority can
be achieved. In cases of new public services or governmental business
activities, the political process is usually quite straightforward. However,
if the object of the corporatization is a well-established part of the pub-
lic sector, the political process may be more controversial.
Before final decisions can be made, administrative preparations
require analysis and list the benefits and disadvantages of the change
in legal status. It is quite normal for different organizational forms
and company types to be compared in order to illustrate differences
and similarities between the governance options of the various organi-
zational forms. It is possible that, as a result of these administrative
preparations, company form is ultimately rejected by political decision
makers and some other form is selected, such as a public foundation or
trust. It would be helpful to include in the documents of the adminis-
trative preparations explanations of the downsides of the old organi-
zational form and how the new form will ameliorate them and what
managerial incentives should be given.
In the corporatization literature, there is a strong assumption that
the process of corporatization is a legislative process (Reynolds and
Von Nessen 1999, 116–117). At the national state government level,
decisions of this magnitude require law drafting and law making proc-
esses. In municipalities, however, the process of corporatization is more
straightforward, without the formalities of such legislative work.
The second phase consists of accountability arrangements. The public
authority needs to define the specific purpose and aims of the company
including the business idea, where and how the company will operate,
what services it will provide and what markets it will serve. According
to Pitkin and Farrelly (1999, 252–253), corporatization is a structural
reform that changes the operating conditions under which state enter-
prises operate in such a way that the conditions are adjusted so as to
resemble a commercial business basis. Because the legally separate units
have to be financially self-supporting, corporatization removes the pos-
sibility to fully fund the public service directly from tax revenues by
introducing an earning requirement. At least in the long run, public
companies have to achieve profitability through sales revenues – which
makes it necessary to develop well-considered earnings principles for
Corporatization as Organizational Innovation 85

the government-owned companies. The accountability arrangements


also include the design of corporation-type accounting, reporting and
auditing requirements. Commercial performance targets are instructed
by setting a rate of return requirement for the company (McKinlay
1998, 232).
One of the core issues of accountability arrangements is to consider
how to appoint the members of the board of directors of the new com-
pany. The main issue to be resolved is what principles are to be used
in the nominations, whether the members of the board of directors
will be nominated based on political majority, proportional political
representation, expertise, or stakeholder representativeness (Valkama
2004, 186). The designers of the government’s ownership policy have
to consider carefully what kinds of incentives can be given to the direc-
tors. On the one hand, newly corporatized units may not face the same
degree of competition as private sector companies: there certainly isn’t
the possibility of unsolicited corporate takeovers in public service sec-
tors that exists in private sector service industries. On the other hand,
the managers of publicly owned companies face the threat of diminish-
ing market shares and insolvency, and they may have to compete for
finance on external debt markets (Bradbury 1999, 163).
In national government, a typical shareholding arrangement has
been to give ownership rights and monitoring and supervision duties
of the incorporated companies to the Treasury or commensurate min-
istries when the companies are important for the functions of the
state government (McKinlay 1998, 232). An alternative accountability
arrangement is to establish a state holding company, this being pre-
ferred in cases when central government considers the incorporated
companies more or less as fiscal investments (Kumar 1993). Municipal
holding companies are still quite rare as only big cities may have the
wide-ranging needs and the administrative capacity for such a business
type of corporate ownership (Högberg 1997).
In the third phase, the scope and depth of corporatization are defined
by drafting the opening balance sheet, the cooperation agreement and
the articles of association. An important political issue to consider is the
debt-equity ratio in the opening balance sheet, whether that leverage
should be greater, smaller or the same as it is for similar companies in
the private sector service industry. If the company has some commu-
nity service or other extra service obligations, it is necessary to identify
these noncommercial services and provide separate funding for these
unprofitable services that the company would not operate otherwise
(Reynolds and Von Nessen 1999, 119). The opening balance sheet
86 Organizational Innovation in Public Services

and the cooperation agreement define very precisely the debt injec-
tions and property items that will given to the new company – which
properties remain with the public authority and which properties will
be rented to the new company. If corporation tax (that is, profits) is a
national government tax, municipalities can be expected to prefer to
rent properties to the new company instead of capitalizing them. If the
municipalities receive profits from the company, they have to pay taxes
on the dividend. However, they can avoid tax if profits are used to pay
rents. A specific extradition treaty can be established between the gov-
ernment and the company in order to specify the items of material and
intangible properties that will be transferred, rented, shared or coowned
with the company. The articles of association resemble the constitution
of a company regulating internal governance principles and mecha-
nisms. The division of powers between the board of directors and the
shareholder(s), the structure, composition and operation of the board
of directors and the areas of business are examples of important govern-
ance issues resolved by the articles of association (Davies 2008, 62–63).
In the fourth phase, registration formalities are simply carried out by
sending the articles of association and the memorandum of association
to the national registration authority with the names of the members of
the board of directors and the auditors of the company. The European
Union Member States may also have to confirm to the EU Commission
whether the corporatized company enjoys any forbidden state subsidies
(Statens offentliga utredningar 2010, 67).

Conclusions

Because of its long history in respect of public utilities such as energy


and water, corporatization in the public infrastructure is no longer very
innovative. However, use of corporatization in the production of welfare
services and merit goods is relatively new and innovative. Unfortunately,
the processes of corporatization of public utilities and personal welfare
services are not distinctly different, as both of them can be seen as top-
down innovation processes generally initiated by senior civil servants or
political leaders, decided by law-makers or city councillors and adminis-
tered by public service managers and working committees.
The processes of corporatization are difficult to democratize and com-
munalize because the processes are distinctive and one-time transfer
operations including highly legal and financial details that are dif-
ficult to simplify for the general public. They typically include only
technocrats such as consultants, lawyers and corporate specialists who
Corporatization as Organizational Innovation 87

provide inventory calculations and drafts of company documents and


shareholders’ agreements and other such materials. The problem is that
too many governments execute the corporatization process as a matter
of routine, paying attention mainly to the detailed legal and account-
ing issues of incorporation. Politicians should also perceive the bigger
picture about the challenges of re-regulation, the governance problems
with quasi-markets, the development needs of competition supervision
and the control of abuse of market power.
The process of corporatization itself cannot deliver guaranteed effi-
ciency savings, nor bring about competition in a two-sided polypoly
referring to an optimal market structure (Budzinski 2003, 6). The proc-
ess of corporatization does not provide any obvious solutions to the
principal-agent problems – how the principal can get valid information
about the real results and efforts made by the agent, and how the princi-
pal can formulate durable incentives and managerial leverages for steer-
ing the agent. As corporatization is a change of legal status, it gives a new
managerial framework where the principal and the agent operate and
communicate by utilizing a business-based performance terminology
and reporting style. Before corporatization, the principal and agent have
a more or less hierarchical relationship subject to public law, but corpo-
ratization transforms the relationship into an ownership-based arrange-
ment, where the government as an investor exercises shareholder rights
possibly supplemented by management-by-contract measures.
Sometimes the process of corporatization has been described as an
autonomization process, but a more precise comparison would be semi-
autonomization since typically politicians staff the board of directors of
the company or at least they have an opportunity to change and re-staff
the board at anytime. In any case corporatization is an extraordinary
change of organizational form that forces the public authorities as the
principal to reevaluate the purpose, aims and functions of the public
enterprise. Realization of the potential benefits of corporatization
ultimately depends on the effective governance of the whole service
system.
Corporatization can be seen as a way to roll back the frontiers of pub-
lic bureaucracy, lower the boundaries between the public, commercial
and nonprofit sectors and replace inward-looking administrative incen-
tives with organizational capabilities promoting customer orientation
and continuous performance improvements. Nevertheless, it would be
wrong to assume that there is no bureaucracy in private law organiza-
tions. There is a risk that corporatization petrifies the dialogue between
the principal and agent by focusing on private sector formalities and
88 Organizational Innovation in Public Services

that the parties cannot find natural ways to communicate content


issues such as ultimate aims and a strategic definition of policies and
investments of the publicly owned company.
Corporatization also opens up possibilities to renew stakeholder relation-
ships by co-governance, joint ownership, sponsorship and new risk-
sharing arrangements as it enables profit-seeking activities, the creation
of subsidiary companies, the receipt of allocated contributions and the
flexibility to join forces with customers and suppliers through panels,
advisory boards, alliances, and so on. Company law is surprisingly
flexible on how the owner can define the purpose and the internal
organization of the company and the distribution of work inside the
company, but the owner has to be creative and goal-oriented to utilize
all the legal options.
Corporatization as an innovation has been successful in the sense that
only a very few incorporated companies have been internalized back to
the public sector or insourced back in-house. Nevertheless it is a much
more complex issue to evaluate what the added value of corporatization
has been for customers and taxpayers. It is the task of future empirical
studies to investigate the effects of corporatization from the perspec-
tives of the citizen and the community, although methodologically this
is a considerable challenge because it may be difficult to distinguish,
on the one hand, the actual change of organizational form and, on the
other hand, all other possible but simultaneous reorganization meas-
ures that may have been implemented regardless of the juridical status
of the service organization.

Note
1. However, if the public authority completely owns the corporation, it is con-
sidered in public procurement law as an in-house unit, which means that
the authority is allowed to make procurements from the corporation without
compulsory competitive tendering (that rule is called an in-house exception)
(Pekkala 2007, 104–107; Zatti 2012, 540–541).

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6
Mutualization and Public Services
Mel Evans

Introduction

The drive toward the externalization of public services and the organi-
zational implications therein have been well-documented in the first
part of this book. In large measure, the driver for this trend has been
to reduce bureaucracy, improve quality and to increase efficiency and
value for money. The inability of the public sector to effectively tackle
these issues internally is cited as a consequence of a lack of capacity to
innovate associated with an aversion to risk, and both these aspects are
seen as inherent to the public sector workforce. Thus the emergence of
the managerial state, creation of quasi-market disciplines, agencifica-
tion and the creation of rafts of quangos (alongside straightforward
privatization) have all been identified, in practice, as aspects of the new
public management, essentially imposed from above.
In recent years, there have been trends in the direction of the mutu-
alization of public services, for example in the UK (Mayo and Moore
2002). Although initially the promotion of mutuals as a vehicle to
deliver public services was not part of the twin furrows of the Third Way
and Communitarianism ploughed by UK Prime Minister Tony Blair’s
New Labour government, the potential for third sector organizations in
this direction was promoted by the Co-operative Party and a range of
sympathetic think tanks (Demos, New Economics Foundation, Mutuo,
among others – Birchall 2011). The creation of a Social Enterprise Unit in
the Department of Trade and Industry and a social enterprise strategy –
while initially geared to the development, support and growth of social
enterprises generally – soon became more directed to public services.
The shift of the Social Enterprise Unit to the newly created Office of the
Third Sector, the ChangeUp program to capacity build the voluntary

92
Mutualization and Public Services 93

sector for social enterprise activity and the creation of 25 social enter-
prise pathfinders within the National Health Service (NHS) are just
three indicative policy initiatives in this direction.
One of the main currents behind the new wave of mutualism was that
the ‘public economy has itself been thrown into question by its capacity
to innovate in response to changing needs and technology, which have
left it weakened in the face of pressures to privatise’ (Murray 2012, 2).
Indeed, a survey of local authority chief executives concludes that ‘risk
aversion has been encouraged, while entrepreneurialism and action with-
out explicit approval have not’ (Morales Oyarce and Kirkman 2011).
So the dominant paradigm has involved the problematization of bar-
riers to innovation from within the public sector, with the prescription
being to externalize service delivery to either the private sector or more
recently the third sector. The potential for what Leadbeater and Goss
(1998) call ‘Civic Entrepreneurship’ – which they define as innovation
involving new products or services, generating space for others to inno-
vate or growing social value from a new idea or practice, but exclusively
from within the public sector – has been starved of the oxygen afforded
to social entrepreneurship (Leadbetter, 1997), in particular the claim
that mutual organizations through their characteristic features guaran-
tee a level of entrepreneurial zeal, risk taking and innovativeness that
cannot be present in the public sector.
‘Mutualism claims many attractive characteristics, particularly when
compared with the key drivers and features of the private sector. The
emphasis on the engagement of the workforce, involvement of clients,
innovation and flexibility are all qualities that should be part of the day to
day work of public service provision’ (Unison 2011, 31). Whether mutu-
alism is the panacea for public service delivery will nevertheless be chal-
lenged. In fact, it has long been recognized that ‘membership involvement
in a mutual does not automatically confer upon the organization the inno-
vative capacity their advocates claim’ (Leadbeater and Christie 1999, 23).

Mutuals and mutualization: Definition and schemata

The central shared idea of a mutual organization is that it is owned


and controlled by its members. Agreement over definition is difficult to
achieve, but there are a number of common characteristics of mutual
organizations:

• Mutuals are established to serve a specific community or interest


group.
94 Organizational Innovation in Public Services

• Mutuals are all ‘owned’ by their members. This ownership is vested


in the membership community of each mutual and is expressed com-
monly. In other words, no individual can take away their ‘share’ of
the assets. Each generation is a custodian of the organization for the
next. There are no equity shareholders, and mutuals do not belong
to the government.
• Mutuals all operate democratic voting systems, with all members
having equal power – one member, one vote.
• Mutuals have governance structures that formally incorporate stake-
holder interests and seek to ensure that these different stakeholders
have an appropriate role in running the organization proportional to
their relative stake (Lewis et al. 2006, 5).

Across Britain and Europe, mutuals appear in a range of forms. The most
widely recognized forms of mutualism in Britain today are probably
building societies, cooperatives, friendly societies and mutual insurers.
Many, however, take the legal form of companies limited by guarantee
and have their mutual membership enshrined in their memorandum
and articles of association. In 2005, a specific legal form (community
interest company) was created for emergent (and existing) mutuals to
be identified as serving a specific community and electing to have an
‘asset lock’ written into the statutes of an organization to prevent the
transfer of resources (including profit) outside the organization. ‘The
inclusion of an asset-lock may well be appropriate for a mutual and can
add credibility because it guarantees to third parties that the society’s
assets will only be applied as determined by the asset lock’ (TPP 2012,
17). This is also seen as particularly important to public service mutuals
entrusted with publicly funded assets.
In the UK alone, according to Mutuo (2010), there were more than
one million people working in mutuals. These mutuals had assets of
more than £500 billion, and had over 74 million members. In 2010, the
gross annual turnover of mutuals in the UK went above £100 billion for
the first time.
In Europe, there is a long history of mutual organizations delivering
services to the public. In Spain, around 550 cooperatives deliver largely
free, state-funded education. In Italy, more than 7,000 social coopera-
tives provide a range of social services and provide work for disadvan-
taged groups. In Sweden, around 1,200 coops provide around 7% of the
national pre-school care for children, even though 80% is still provided
by the state. The key features of such public service provision by mutu-
als are that – enabling legal frameworks and state fiscal support – access
Mutualization and Public Services 95

to capital and positive approaches to commissioning and procurement


have all been key to such success (Bland 2011).
Such definition by characteristics is useful to identify organizational
type and for the most part ‘social enterprise’, a term widely understood
and popular across Europe, fits this mutual description with the key
distinction that social enterprises can go beyond being just of benefit
to members. The characteristics of mutualism are also, however, appli-
cable to the wider third sector (non-state and non-private sector). The
term has been used to describe forms of economic organization, com-
mon ownership, where companies in the private sector give employees
a stake in the organization (e.g., the John Lewis model). Over recent
years, the idea of social mutualism has emerged as a form of public
service reform in which providers and users of public services acquire
greater control over the running of those services.
Then, in a public sector context, mutuals can be employee owned,
cooperatives or social enterprises, but essentially they are:

• Owned/controlled by their members


• Run democratically on the basis of one member one vote
• Set up to meet the mutual needs of their members
• Not set up to make profits for external shareholders or primarily
provide a return on capital
• Share any surplus or profits (the dividend) with their members (HM
Treasury 2008, 7)

But the UK government, in pursuit of new ways of delivering pub-


lic services, has specifically defined a ‘public service mutual’ as – ‘an
organisation which has left the public sector “parent body” (also known
as “spinning out”) but continues to deliver public services’ (Mutuals
Taskforce 2011, 9).
This aspect of the emergence of new mutuals has become a central
focus for the future of public service delivery and the organizational
forms that deliver them. But mutuals have features that are not common
within private and public sector organizations or at least are features
that are not so prominent there. One in particular is that mutuals trade
in intangible assets, on ‘their ability to win their member’s trust and
garner their ideas’ (Leadbeater and Christie 1999, 20). In short, they
thrive through building social capital, and this has been claimed as an
important feature of social enterprises (Evans and Syrett 2007). Although
these social capital networks can extend beyond the stakeholders of the
organization, it is through the membership network that the innovative
96 Organizational Innovation in Public Services

energy of the mutual is said to thrive since it is claimed that ‘they use
their membership structure to unlock innovation’ (Leadbeater and
Christie 1999, 14).

The mutualization policy agenda: Aims and benefits

The policy agenda


In the UK, as in Europe, the government interest in mutuals as a means
to deliver public services pre-dates the austerity politics of the post-credit
crunch world. As outlined earlier, the Blair government in pursuit of a
third way and the empowerment of community organizations had a
history of outlining strategies to diversify public service delivery as part
of the modernization and choice agendas (ODPM 2005; HM Treasury
2007). Somerville notes that ‘the Labour government had long been keen
however, on the so-called “modernisation” of public services, and it saw
mutualisation as an attractive (because it’s a “third way” kind of thing)
and effective means of achieving this aim’ (Somerville 2011, 130).
But of course, there is a much longer history to mutual activity than pre-
credit crunch, in the UK, Europe and elsewhere. It is in the UK that the first
significant consumer involvement in cooperation began with the Rochdale
Pioneers in 1844. These were followed by a whole raft of Co-operative
Societies and later workers’ cooperatives. But it was not just cooperative
organizations that were involved in provision of services to working people
where the state did not. Indeed in the instance of health services a range
of organisations (some of which still survive – e.g. the Hospital Savings
Association) emerged to meet the needs of working people (Birchall,
2011). Such grass roots bodies included friendly societies to provide sick-
ness benefits to members, medical centres to deliver care, and even coffin
clubs emerged to meet the needs of working people (Birchall 2011). The
creation of the welfare state removed the need for many of these, especially
through the creation of the NHS, after 1945, against the advice of William
Beveridge, the architect of the welfare state who feared that the ‘social soli-
darity’ of such mutual provision would be lost (Birchall 2011).
The next wave of mutualism emerged in the 1990s due largely to
both public service devolution and privatization, and the debate around
efforts (mostly successful) to demutualize building societies and mutual
insurers. With regard to the former, local authorities started to scru-
tinize mutual organizations as ways to manage and maintain public
services like leisure centers, refuse and recycling collections or home
care. The Care in the Community Act 1990 created a market for third
sector organizations to provide care in the more mixed economy that it
Mutualization and Public Services 97

generated. One of the earliest local authority supported mutuals created


to provide home care services was Wrekin Home Care Co-op in 1991;
this was preceded by Sunderland Home Care Associates in 1990, a coop-
erative that in its current form has a turnover exceeding £2.3 million a
year. The creation of Wigan Leisure and Cultural Trust by Wigan Council
in 2003 as an independent charity was the first of such externalizations.
Although initially refused charitable status by the Charity Commission
for not being sufficiently independent of council interests or having
sufficiently charitable purposes, on appeal the status was granted on
the basis that it had an open process for membership and governance
as well as appropriate provision to manage potential conflicts of interest
due to council representation on the board of trustees.
This decision opened the door for the creation of over 100 such
Leisure Trusts in England and Wales with a combined turnover of over
£750 million, providing a range of services from non-statutory ones,
such as swimming pools and theatres, to statutory ones, such as librar-
ies. It was therefore a landmark decision by the Charity Commission.
The attraction of such trusts lies not only in the charitable status that
enables at least 80% tax relief of the payment of non-domestic rates (the
local tax on business properties) but also that trusts are able to gener-
ate funding from other sources such as the National Lottery and other
charities in order to support its services (Cook 2011).
Following mixed success with creating quasi-markets and internal
competition in the National Health Service, in 2002 the UK Labour gov-
ernment announced the creation of Foundation Trusts that were part of
an effort to create more patient-led and ‘choice’-based health services.
The model followed was to be along the lines of creating mutual organi-
zations (trusts) and boards with NHS staff, patients and local representa-
tives involved in governance. There are now 141 such trusts that have
been created since 2004 (Michie 2012).
The UK Labour government from 1997 to 2010 promoted the devel-
opment of mutuals and particularly social enterprises largely outside
state structures, and indeed even within the private sector – for exam-
ple, through the creation of Supporters Direct to promote the demo-
cratic ownership of football clubs by their supporters via mutual trust
structures (HM Treasury 2007). As noted earlier, schemes to capacity
build the voluntary and community sectors as mutuals to bid for public
sector contracts were developed such as Futurebuilders and ChangeUp,
but these have had mixed success as such mutuals still came up against
difficulties in bidding for tenders generated via the procurement strate-
gies of public authorities that still seemed biased toward private sector
98 Organizational Innovation in Public Services

bidders. The formation of a coalition government of the Conservatives


and Liberal Democrats to succeed Labour in May 2010 saw a stepping
up of the mutualization agenda however.
The growth of support for mutualization under the coalition govern-
ment was rapid and encouraged expressly ‘to deliver public services,
with the onus placed on public sector workers to bring about such
a change’ (Michie 2012, 6). The first significant statement of intent
from the new government was the creation of 12 ‘pathfinder mutuals’
to blaze a trail with the new way for public service delivery in August
2010. This was followed by the creation of a ‘right to provide’ public
services to be rolled out and made available to public sector workers in
every government department on the basis of ‘spinning out’ from the
public sector.
The Comprehensive Spending Review of October 2010 proposed ‘a new
right for public sector workers to form employee-owned co-operatives
and mutuals to take over the services they deliver’ (HM Treasury 2010,
35). Within a month, the coalition government’s Minister for the Cabinet
Office, Francis Maude, announced a £10 million pathfinder fund (the
Mutuals Support Programme – MSP) to be created and available from
July 2011 to help charities and social enterprises bid for public service
contracts. Alongside this, there was to be a new information line and
Web service for government staff who were interested in ‘spinning out’.
Then in December 2010 the government published the Modernising
Commissioning Green Paper (Cabinet Office 2010) to open a dialogue
concerning the complexity facing commissioners of services and referred
to the range of charities, mutuals, cooperatives and social enterprises
collectively as ‘civil society organizations’ that would be more encour-
aged and supported through the MSP to bid for government contracts –
perhaps to ‘spin in’ as opposed to public sector worker-led mutuals
(Public Service Mutuals [PSM]) ‘spinning out’. The focus of decisions
regarding award of contracts was to be shifted from cost to price and
value. That such public service mutuals faced a number of challenges
including risk management, negotiating the transfer of undertaking and
assets and the rules governing this (Transfer of Undertakings of Public
Employees [TUPE]) and dealing with Value Added Tax (VAT), however,
was also recognized by the government.
Such challenges were the driver behind the creation – in February
2011 – of the Mutuals Taskforce, the role of which was ‘to engage with,
challenge and promote the work of the government to support the
creation and development of public service mutuals’ (Mutuals Taskforce
2011). The initial focus of the Mutuals Taskforce has been about the
Mutualization and Public Services 99

right to provide and the initial 11 pathfinders, and the further 7, cre-
ated in February 2011, are as much a laboratory for the mutualization
experiment as an effort to identify and examine the claimed benefits
of mutualization, in particular employee ownership and membership
systems.
The government, however, has consistently stated its claim as to the
benefits of mutualization to ‘empower millions of public sector staff
to become their own boss – freeing up untapped entrepreneurial and
innovative drive’ (Cabinet Office 2012, 11).

The claimed benefits of mutualization


Primary among the claims for the benefits of mutualization is some-
thing that the process shares in common with many small business
initiatives – a sense of ownership by those working for the enterprise.
So ‘potential productivity gains that may come from a feeling of
ownership . . . can create a sense of commitment to the company and
hence greater effort and innovation’ (Michie 2012, 4). It is, therefore, to
the area of employee ownership that the Mutuals Taskforce has largely
turned, and it claims that ‘the case for employee ownership and control
depends in large part on the justification put forward for employee
engagement’. This justification identified two main types of benefit
deriving from such engagement.

• Intrinsic benefits: These are benefits to the employees; in other


words, their engagement in the organization has a positive impact
for them.
• Instrumental benefits: These are benefits to the services provided by
the organization – that employee engagement in some way improves
service delivery, for example, better quality services, employee satis-
faction, reduced costs or higher productivity.

Intrinsic benefits are that mutuals, as with other employee-owned


organizations, particularly enable self-determination: this rests on the
distinction between autonomous (or self-determined) actions as against
controlled actions (those influenced by factors beyond self). The theory
of self-determination (Deci and Ryan 2000, cited in Mutuals Taskforce
2011) is that employees are more motivated if self-determined actions
exceed controlled actions to generate greater employee satisfaction.
This is considered especially so for professional groups. Such employee
engagement generates other intrinsic benefits in that there is a clai-
med link between employee engagement, emotional intelligence and
100 Organizational Innovation in Public Services

well-being (Kuler et al. 2008). As a consequence, there is evidence that


in mutuals:

• Absenteeism is lower
• Staff turnover is lower
• Staff retention and recruitment of high quality staff appears to be
easier
• Pay is higher on average than in non-employee owned enterprises
• There is better staff performance (Mutuals Taskforce 2011)

Instrumental benefits are claimed to follow from intrinsic ben-


efits in that greater employee satisfaction – sense of well-being and
commitment – leads to greater engagement, and this in turn improves
the efficiency and quality of services that the organization delivers.
Here the Mutuals Taskforce relies for evidence upon the Macleod Review
of employee engagement in the workforce (Macleod and Clarke 2008).
This generally found a virtuous circle of engagement, leading to instru-
mental benefits for service delivery. Three particular factors were identi-
fied in the Macleod Review as a consequence of employee engagement,
and these were benefits in terms of attitude, behavior and outcomes.
As a consequence, mutuals as employee-owned organizations are more
likely to:

• Deliver greater customer satisfaction: The Mutuals Taskforce


(2011) cite evidence from the Towers Perrin report (2007) that 79%
of engaged employees felt they made an impact on the quality of
service delivered and this was important to them.
• Innovate: The Mutuals Taskforce (2011) consider that ‘innovation
though sustainable learning activity is better achieved in conditions
where employees can more readily shape and own their own profes-
sional futures where new ways of working are encouraged by adopt-
ing inward and outward looking perspectives and where enabling and
empowering participation is valued’ (Mutuals Taskforce 2011, 17)
• Lower production costs and higher productivity: Evidence from
ACEVO (2010) is cited that Sandwell Community Care Trust halved
their spend on overheads in the 10 years after their spin out from the
NHS (Mutuals Taskforce 2011, 17)
• Create jobs at a faster rate: Evidence is cited from a study by Lampel
et al. (2010) that this is the case even during recession.
• Be profitable and resilient: Again, the Mutuals Taskforce cite evi-
dence to support this claim from the Employee Ownership Index
Mutualization and Public Services 101

(EOI) that ‘From 1992–2010 the Index demonstrated employee-


owned firms consistently outperforming against the FTSE All-Share,
showing the strong performance and resilience of these organisa-
tions’ (Mutuals Taskforce 2011, 18)

In conclusion, and based on examination of evidence, ‘well designed


mutualisation in the public services has the potential for yielding con-
siderable benefits in a wide variety of contexts’ (Mutuals Taskforce 2011,
20). However, ‘most of the evidence comes from what is conventionally
thought of as the private sector’ (Mutuals Taskforce 2012, 18).
There is now a clear definition of what a Public Service Mutual is:
‘A public service mutual is an organisation which has left the public
sector “parent body” (also known as ‘spinning out’) but continues to
deliver public services. Mutuals are organisations in which employee
control plays a significant role in their operation’ (Mutuals Taskforce
2012, 9). Legal forms can vary: company limited by guarantee (or
shares), industrial and provident societies and, increasingly, community
interest companies (largely due to the attraction of an asset lock) are
the most common forms. The business model can be for profit or not-
for-profit (or more strictly speaking, not for private profit distribution)
and the membership categories can also vary (employees, service users,
customers, community groups and public authority representatives),
but a mutual is always membership-based ownership and control,
even though they differ in terms of the extent of member involvement
(Unison 2011, 14). But above all a Public Service Mutual is distinct
from other mutuals in that it has ‘spun out’ either through top-down
public authority creation or employees exercising their right to provide.
It is significantly different from other mutuals emerging from the ‘civil
organisation’ or third sector that are seeking (perhaps through the ‘right
to challenge’ as enshrined in the Localism Act 2011) to deliver public
services (‘spin ins’).
Local authorities are opened up to further mutualization through both
the ‘right to provide’ (public sector staff-led spin outs) and the ‘right to
challenge‘ (mutual organizations in the community sector requesting
that services are put to tender and bidding for them – what we have here
called ‘spin ins’).
A range of support mechanisms are in place in addition to the £10
million Mutual Support Programme (MSP), which provides support to
emerging mutuals. The Social Enterprise Investment Fund (SEIF) was set
up under the Labour government in 2007, and that it survives reflects
the continuity of the public service mutualization agenda seamlessly
102 Organizational Innovation in Public Services

across the transition between the Labour and coalition governments.


Over £100 million has been invested through SEIF in the health and
social care sectors and ‘right to request’ and, later, ‘right to provide’
claims have contributed to over 600 social enterprises (a common
form of mutual, now best expressed in the legal form of a Community
Interest Company) delivering health and social services in England and
Wales. The Mutuals Taskforce is also overseeing a ‘pipeline’ of emerging
mutuals and strives to support these to maturity, and there is now a sig-
nificant number of public service mutuals active or being developed.
The community right to challenge which will enable a ‘relevant body’
(a voluntary or community body, a charitable body or trust, a parish
council, or employees of a public authority) to express an interest in
running a local authority service and secure a procurement exercise, is
thought likely to be a ‘powerful tool to open up public service markets’
(TPP Law 2012, 12).
In addition, the Public Services (Social Value) Act 2012, which came
into force in February 2013, requires all public authorities to consider
‘economic, social and environmental well being’ when procuring or
making arrangements for the provision of public services within their
area of jurisdiction. This is likely to considerably increase opportunities
for mutuals to win public service contracts, although is not exclusively
applicable to them.
The policy support for mutualization needs to be seen in the con-
text of a wider public service delivery agenda, driven by the effort to
encourage efficiency, reduce costs, and increase user and community
involvement. This ultimate aim of the UK government is identifiable
in the effort to change the perception of what it means to be a public
servant whereby ‘all those who serve the public will have the right to be
recognized as public servants – regardless of whether the organizations
for which they work are traditional public sector agencies, independ-
ent trusts, employee mutuals, private enterprises, social enterprises or
community groups’ (Cabinet Office 2012, 13). Whether such a radi-
cal shift of responsibility for public services to civil society is broadly
accepted depends upon the legitimacy of claims for the emergence of
a Big Society (Birchall 2011). Alongside community empowerment and
social action, opening up public services was to be the third element
of the Big Society agenda. The promotion of mutuals locks together all
three of these elements. But the potential for success of such a project –
dependent as it is upon a fundamental tautology of grass-root action
driven by a centrally constructed agenda of responsibilization – is seen
to be limited (Stott 2011).
Mutualization and Public Services 103

The process of mutualization

The process by which mutuals emerge differs in regard to whether we


are dealing with spin outs or spin ins. Mutuals (however defined) that
emerge outside public sector organizations and ‘spin in’ emerge in the
main from grass-root organizations. They are rooted in the social capital
of either place or interest-based community networks seeking to meet
community needs (Evans and Syrett 2007). That they go on to bid for
and perhaps win public service contracts in large part derives from their
response to the withdrawal of public authorities from the delivery of
that service. In the UK, this has been the case since the introduction at
local authority level of Compulsory Competitive Tendering (CCT) in the
1980s, and this is what ignited the growth of organizations like Ealing
Community Transport (ECT) and Hackney Community Transport (HCT),
both of which were relatively small local voluntary organizations meet-
ing the transport needs of voluntary and community groups which won
local contracts for recycling waste and now have multimillion pound
turnovers. So, elements of a sector containing grass-root–based mutuals
emerged within new local markets created by such legislation.
What are now referred to as Public Service Mutuals, however, emerge
from a process of ‘spinning out’ from a public body, rather like the
Leisure Trusts detailed earlier, and in doing so are engaged in a sequence
of activities the careful negotiation of which should ensure a successful
route to independence and public service mutual status. The Mutuals
Taskforce sees this in terms of three phases:

1. Pre–spin out phase: This phase commences when either the public
authority or a group of its employees, normally a professional team,
identify and express an interest in developing and running a public
service mutual. What ensues would be a period of business planning,
awareness raising and negotiation among the workforce and the pub-
lic authority. The barriers to this phase would include any resistance
to the intended spinning out of a service and clearing a pathway for
mutualization, securing support from the public authority to achieve
this, and, naturally, securing impartial advice and expertise and the
financial resources to commence the process.
2. Spinning out or set up phase: This will be part of the process
whereby a number of technical issues will require resolution. These
will include identification, assessment and transfer of employment
rights of the staff spinning out. This will mainly involve adherence
to the TUPE regulations, an assessment of current arrangements and
104 Organizational Innovation in Public Services

future provision of pension entitlements, the assessment of VAT costs


and any other tax liabilities of the proposed public service mutual,
and finally the identification, assessment and negotiation of the
transfer of assets (i.e., premises, vehicles, plant, stock, etc.) at present
publicly owned but vital to the continued delivery of the public
service. In both this and the first phase, the continued engagement
of staff, trade unions and/or professional bodies will be vital.
3. Sustainability and growth phase: This phase is after set up, when
long-term sustainability and growth is sought. Perhaps diversifying
into an allied trade, looking to secure new contracts in both the pri-
vate market and other public sector locations will be a feature. By this
stage the mutual should be developing employee skills and abilities
in the commissioning process and practices. The mutual may also
look to secure finance to enable growth.
The issues faced by emergent public service mutuals in the proc-
ess of mutualization and the public authorities that they are spin-
ning out from are numerous and complex, which is why it can take
between 2 and 3 years (APPG 2011). The main issues can be grouped
into three areas.
i. Human resources
Loss of in-house human resource expertise and support upon externaliza-
tion. Some mutuals may seek to contract for the continued support
of the HR service of origin, but this will come at added cost. The
range of skill requirements to be covered following mutualization
will include negotiations with trade union and other staff repre-
sentative bodies over ongoing and emergent issues. These are in
addition to the skills for taking the mutual through TUPE.
A significant HR issue concerns the existing and future pension
rights of employees. The potential loss and necessity to transfer pen-
sion scheme is often cited as an issue central to any resistance on
the part of public sector employees, especially when public sector
pension schemes are generally more lucrative than those available
outside the sector. However, it can be the case that the new mutual
can be viewed as an ‘admission body’ to the Local Government
Pension Scheme (LGPS) in the UK (TPP Law 2012) under which the
new mutual agrees to pay to the pension fund the contributions
of transferring employees. But future contribution costs to the
LGPS may rise and be out of the control of the new PSM, and thus
increasing payroll costs. Also such a deal does not exist for mutu-
als spinning out from the National Health Service. The uncertainty
over future pension entitlement is an aspect that ranks high in the
risk list of public sector employees considering mutualization.
Mutualization and Public Services 105

Employees within the new PSM may also now discover that
they are working under an expected ethos of disinterestedness that
can become oppressive in that ‘senior managers may consider
that everyone involved in the enterprise should be politically
and emotionally committed to the purpose and aims of the
organisation, and should thus behave accordingly. This can lead
to individual employee rights being overlooked or even sacrificed
in the drive to deliver the social purpose’ (Michie 2012, 12). This
phenomenon is already one recognized in the broader voluntary
and community sector in which such an ethos is expected of
those paid to do the work.
ii. Organizational issues
The likely loss of a centralized HR function is a factor of the nega-
tive impact of change in scale that managers and employees of the
new PSM will experience. This downsizing to a human scale is
often cited as a beneficial aspect that PSMs enjoy, as discussed by
Murray (2012) in terms of the Dunbar number (the level at which
strong ties in human relationships become difficult to sustain –
150 is the suggestion). However, a negative consequence is that
a range of functions now have to be conducted within the limits
of the skills set shared by a smaller team. The loss of economies
of scale can be damaging to the PSM.
The need for the PSM at the sustainability and growth phase to
firstly have access to the market for capital (when all public sources
of finance and resource support may have subsided) is something
that a PSM in its spinning out phase may not consider. This is not
only a dilemma for the PSM but for public bodies also, as while
the PSM can borrow against its asset base, these assets have origi-
nally been created and paid for using taxpayers’ money (Unison
2011). This is the reason why an “asset lock” (a legally binding or
contractual tool preventing asset stripping upon winding up or
the temptation for demutualization among members) is consid-
ered important (and indeed is a feature of the new legal form of a
Community Interest Company). For the PSM, however, the asset
lock can reduce the likely credit pool available to it on the open
market as lenders become aware of restrictions to their access to
recourse to assets in the event of default.
A second issue here is that the growth that is looked for in the
spun-out phase will be dependent upon the PSM finding new
contracts with the public sector (and possibly the private sector
dependent upon the market) beyond the initial services that were
the focus of the spin out. PSMs can under current conditions lose
106 Organizational Innovation in Public Services

their delivery contract after 3 years (possibly less if defaulting on


terms) and will certainly face private sector competition from
organizations less concerned with living wages and decent condi-
tions of service. PSMs need to quickly move from a dependency
with the public service of origin to avoid the inevitable conse-
quences of monopsony (i.e., sole buyer), especially if the public
authority decides to cease provision of the service.
A further issue concerns the PSM having to deal with the
burden of costs and activities that the service was not subject to
when under the control of the public authority. A major instance
here is VAT. It is a complex issue, but in the majority of cases,
public authorities throughout Europe are not required to pay or
account for VAT. This of course is not the case for the new PSM,
and they must therefore budget for significant new costs for
service delivery associated with payment of VAT. These can of
course be factored into charges for service delivery and reclaimed
by the public authority from the government tax authorities. But
it is also managing (and paying for) the accounting services and
advice that is required to ensure that the VAT liabilities are prop-
erly calculated and executed, which may prove to be a further
burden for the PSM.
Public authorities procuring goods and services are subject
to EU directives on procurement, which are implemented in
national law of member states. In the UK, these are instruments
created under the European Communities Act 1972 – currently
these are the Public Contracts Regulations 2006. Under these
regulations, it is a requirement that all contractors be treated
equally, including PSMs. This makes a difficulty which arises as
early as the pre–spin out phase: what would motivate a group of
public sector employees to design a spin out whereby their future
wealth and welfare will be decided on a level playing field with
as yet largely unknown competitors who may be better equipped
and prepared to win the contracts in the future that they are busy
externalizing? Turkeys voting for Christmas comes to mind.
iii. Wider environment
Just as PSM employees may be subject to an ethos that places
stress upon them, even when they are in agreement with that
ethos, in the wider environment there will be pressures of image
and perception as a consequence of what will be seen as their
autonomous actions. For many, a PSM is still a beast of the pri-
vate sector regardless of its membership or objectives. PSMs are
Mutualization and Public Services 107

therefore subject to the criticism that they are stepping stones


on the road to privatization (Murray 2012). Even if the PSM has
a membership fully committed to the mutual ethos and pro-
tecting the quality of public service, it may not be sufficient to
ward off efforts to demutualize. Indeed, experience has shown
in past periods of high levels of demutualization, that the threat
to demutualize is usually from within (Birchall 2011) and this
militates against the ambitions of the PSM toward democracy,
transparency and open membership.
Even if the PSM manages to protect against threats of demu-
tualization, there remain criticisms of potential profiteering at the
expense of the taxpayer that require consideration. PSMs can deflect
such criticisms through both a lock on assets and also adopting the
status of ‘not for private profit distribution’. It should of course be
noted that having a status or claim for being ‘not-for-profit’ is not
a defining feature of a mutual. But even when this is adopted by a
mutual, profit is not subject to legal definition and is in account-
ing sense conventionally calculated on the basis of the financial
surplus of an accounting period when total costs are deducted
from total revenue. But if wages, bonuses and dividends to mem-
bers are included within total costs, and such costs are perceived as
excessive, the issue of ‘not for profit’ can be rendered meaningless
and a hollow marketing ploy more redolent of the realm of corpo-
rate social responsibility. But even when cooperatives and mutuals
remain true to their ethos throughout their membership, the state
sector also remains suspicious of them and views them as ‘risky’.
‘Partly the state has seen co-ops as riskier to deal with than large
private sector providers, and in the case of small co-ops involving
greater transaction costs’ (Murray 2012, 5).
Finally the concerns and criticisms emerging from the public
sector workforce and articulated by the trade union movement
should be taken into account: First, there is no inherent ground-
swell of support among public sector staff for mutualization.
Research on the UK government intention to give a ‘right to
request’ for local authority staff teams to set up a social enterprise
to deliver their services to the council shows that 64% of such
staff thought this right would not be exercised (TPP Law 2010).
A similar survey showed that only 17% of the local authority staff
surveyed was aware of any likely right to requests to provide pub-
lic services through a mutual being put forward by local authority
staff (Evans forthcoming).
108 Organizational Innovation in Public Services

Second, if it is the case that innovation in the private and


mutual sector is more prevalent for reasons cited earlier, does
this rule out any possibility of the conditions for innovation
being created in the public sector? There is much evidence of the
practice of innovation in the public sector (Leadbeater and Goss
1998; Mazzucato 2011), and thus a pertinent question may be
raised – If the benefits of collaboration between different sets of
public sector workers is perceived as social innovation, then ‘why
does it require these groups of workers to be removed from the
public sector before they can work together?’ (Unison 2011, 19).
Third, if mutualization is so conducive to social innovation
and generating a balance between efficiency and social benefit,
then why are there not similar efforts on the part of governments
to promote and support mutualization in the private sector? Of
course conversions of private companies to employee-owned
mutuals, albeit rare, do happen (often as a bequest from philan-
thropic owners – e.g., Scott-Bader). While there may be resistance
from the private sector at any plan to extend the possibilities of
mutualization within private firms ‘It would be logical for the
government . . . at the very least to allow the staff within to
have the legal right to request such a change’ (Unison 2011,
29). Indeed, it is usually the case that conversion of a firm to a
worker cooperative is often only considered for ‘lame ducks’ (e.g.,
Triumph at Meriden – see Rosamund, 2009) or suggested govern-
ment experiments among poor communities (Evans 2008).

Conclusions

As a response to the challenges of the public economy of the 21st century


and its capacity to innovate and respond to technological change and
globalization, mutuals have been promoted as a viable alternative to the
shift toward privatization which ‘has itself exposed the limitations of
profit-driven services and their regulation’ (Murray 2012, 2). If mutuali-
zation is to be the future of public services as claimed, then there will
need to be a concomitant cultural shift concerning ownership, control
and the rewards to them (Michie 2012). Moreover, what constitutes ‘the
public’ will require re-examination in such a context. Such a redefini-
tion is of course required in a world where global economic processes
erode the very presence of public land, public space, public arena and,
of course, public service and its relationship to the modern state. It is
likely to take more than a general broadcast of responsibility for the
Mutualization and Public Services 109

delivery of services long perceived as the responsibility of the state, to


civil society and a vacuous notion of Big Society to accomplish lasting
change.

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7
Organizational Innovation in
Public Procurement in Scotland:
The Scottish Futures Trust
Darinka Asenova

Introduction

Over recent years, the UK has witnessed the evolution of new methods
for procurement of public services infrastructure (Asenova et al. 2010;
Bailey et al. 2009). Aiming to address the shortcomings of previous
public procurement models, these new methods display innovative
characteristics in terms of financing, operation and implementation of
public services infrastructure and the services thereby provided.
Public services in the UK have been subject to criticism in terms how
adequately they respond to public needs and demands. For example,
Chapman (2004, 23) referred to ‘the perceived crisis in the ability
of the government to deliver improved performance in key areas of
public service’. While the standard Private Finance Initiative/Public
Private Partnership (PFI/PPP) model has been utilized for the renewal
of the UK’s public sector infrastructure, there have been ongoing con-
cerns about its excessive costs to the taxpayer and so poor value for
money (VFM).
The PFI/PPP payments made by a public sector procurer to the Special
Purpose Vehicle (SPV) established to finance, construct and manage the
infrastructure are set down in a legal contract and indexed to inflation.
Hence, the maintenance of these payments (‘unitary charges’) has sig-
nificant budgetary implications for the quantity and quality of public
services, not just those provided by the PFI/PPP but also other services
facing budgetary inflexibility as a consequence of that legal obligation
to pay unitary charges.
In Scotland, the payments for existing PFI/PPP contracts will amount
to £983 million in 2013–14 and £1012 million in 2014–15 (Bell 2012).
Critics of PFI/PPPs have also highlighted contractual and service

111
112 Organizational Innovation in Public Services

failures as well as the lack of significant risk transfer as public sector


organizations have sometimes had to bail out failed projects. The inter-
generational transfer of debt and other liabilities of PFIs have become
an increasingly contentious issue in conditions of budget cuts and aus-
terity measures.
In Scotland, the Scottish National Party (SNP) has always opposed
PFI/PPPs that were established by the UK Conservative central govern-
ment in 1992. While in opposition, the SNP proposed and developed
the Scottish Futures Trust (SFT) as an alternative to PFI/PPPs.
After four years as a minority government, in 2010 the SNP was elected
to power. In office, the SNP Government has faced a combination of
factors, increasing the demand for public services, including rising
poverty; unemployment; social exclusion; income, gender and health
inequalities; ageing population; poor educational attainment; economic
underperformance. These challenges were compounded by the eco-
nomic downturn and the sweeping changes introduced by the 2010 UK
Conservative – Liberal Democrat Coalition Government to taxation and
welfare policy, coupled with budget cuts and other austerity measures.
These fiscal challenges presented an opportunity for ‘democratic
experimentation’ (Habermas 1996) to turn the crisis into a driver for
developing innovative and cost-effective needs-based solutions. In his
analysis of evidence-based policy in Scotland, Saunderson (2004, 72)
noted that the SNP government’s commitment to service outcomes
should encourage the development of ‘deliberative forums that are
inclusive of the range of interests and knowledge silent in the discus-
sion of policy issues’ while adopting a flexible ‘trial-and-error model
of policy making’. A more adaptive model should be built around
proactive learning-based approach and innovation. Learning is the key
way to handle complex issues associated with lack of predictability
and control (Chapman 2004, 12). From such perspective, learning and
innovation are cultural issues fostered by an open-system environment
and nontraditional thinking. The following analysis utilizes elements of
Chapman’s open system approach.
Governments regulate core services, specifying standards and moni-
toring services against international benchmarks and provide a safety
net endorsed by national or international agreements such as public
health, security and infrastructure (CIPFA 2007). By learning from the
PFI/PPP experience, the detailed guidance produced by professional
bodies and the well-publicized successes and failures of PFI/PPPs, the
SFT has the opportunity to encapsulate those lessons into the next stage
of organizational innovation.
Procurement Innovation: The Scottish Futures Trust 113

This chapter now goes on to analyze the SFT as an example of a new


type of organizational form and new governance arrangement created
by the Scottish government to drive service improvement, innovation
and democratic experimentation. The analysis is based on a range of
documentary sources, including government policy documents, policy
papers from government departments and industry bodies, SFT corpo-
rate plans and annual reports, academic papers and publications in the
media.

Evolution of the SFT and its governance model

Pautz and Bailey (2012) provide a detailed discussion of evolution of the


SFT summarized here and depicted in Figure 7.1. In search of an alterna-
tive to PPP/PFI, in 1999 the SNP proposed a new policy instrument –
the Scottish Public Service Trust (SPST). The initial idea envisaged a
number of ‘trusts’, each set up to service a different sector such as
housing, leisure and health. These trusts were to operate as limited and
non–profit-making companies financed by issuing bonds. However, the
policy was drafted without sufficient consideration of the Scottish gov-
ernment’s lack of powers to issue bonds, and hence the initial proposal
had to be abandoned. In 2007, the trusts were combined in a single
entity the SFT.
The SFT still cannot provide direct project funding, and its main role
is to act as an arranger (rather than provider) of funding of infrastruc-
ture, also providing project expertise and commercial advice. In 2010,
the SFT facilitated the use of Tax Increment Financing (TIF) by Scottish
local governments, which unlike the Scottish government do have
powers to borrow. TIF uses the additional business property tax revenues
arising in the future, from the (hoped for) increases in property values
resulting from the new infrastructure, to finance the local government
borrowing required to fund that infrastructure.

SPST SPST SFT SFT


proposal is is included proposed created
launched in the SNP’s based on based on
by the SNP 2003 election the NPD NPD
in opposition manifesto model
1999 2003 2007/08 and TIF 2010
but it is not introduced
elected to
power

Figure 7.1 The main milestones in the SNP’s development of the SFT
114 Organizational Innovation in Public Services

The SFT also has to act as a ‘gatekeeper’ of the non-profit distribu-


tion (NPD) model (already in place prior to establishment of the SFT)
and provide financial ‘underpinning’ for new projects. Specifically, the
Scottish government instructed the SFT to make significant cost savings
(£100–150 million per annum), which have to be invested in Scotland’s
capital infrastructure (The Scottish Government 2008a, 5). Additionally,
a proportion of senior debt is provided by the Scottish government in
order to reduce funding costs and ensure that the initial senior debt is
secured on better terms.
Despite being denoted as a ‘trust’, the SFT is an independent limited
company wholly owned by the Scottish government (i.e., a quango) and
accountable through its board of five nonexecutive directors. Under sec-
tion 251 of the Companies Act 2006, Scottish Ministers are considered
to be shadow directors of the company (SFT 2010a, 4).
By its constitution, the SFT has (at least for Scotland) a unique hybrid-
type governance structure. As noted earlier, it is a private not-for-profit
company that is tasked with promoting the public interest by adopting
a public sector ethos. According to its Memorandum of Association, its
non-profit distributing status means that all income and property of
the company is applied solely toward the promotion of its objectives
and no profit is made by its members (SFT Memorandum of Association
2008, 5). It is tasked by the SNP Government with the provision of
service-based public sector assets both directly and indirectly (e.g., by
supporting local companies).

It aims to improve the efficiency and effectiveness of infrastructure


investment in Scotland by working collaboratively with public bod-
ies and industry, leading to better value for money and ultimately
quality of life. The SFT will act across all phases of the infrastructure
investment cycle: needs identification, options investigation, invest-
ment appraisal, procurement, financing, design, construction, life
cycle management/maintenance and disposal with a particular focus
on planning, financing and procurement (SFT 2009a, 4).

Consistent with its key strategic role as a financial advisor across all
public authorities/services in the planning and delivery of infrastruc-
ture projects, the SFT is also the first organization in Scotland to pro-
mote shared infrastructure models, a concept which has since become
increasingly important.
The SNP government’s 2008 Infrastructure Investment Plan made
explicit its commitment to economic growth and high quality public
Procurement Innovation: The Scottish Futures Trust 115

services through capital investment in physical assets and affirmed the


key role of the SFT (The Scottish Government 2008a, 9). Another key
2008 document, ‘Taking Forward the Scottish Futures Trust’, developed
the new service provision model in more detail highlighting the dif-
ferences with PFI/PPP in particular (The Scottish Government 2008b).
Reflecting the political and ideological shift of the SNP government,
the NPD discourse was seen as an opportunity to build on the lessons
learned from PFI/PPP and address recommendations for public procure-
ment in Scotland made by two earlier reviews (McCLelland 2006; Audit
Scotland 2008).
In recognition of the need for service improvement and innovation,
the SFT’s 2009 inaugural corporate plan stated that one of the key gov-
ernment objectives is to ‘innovate and bring fresh approaches and mod-
els for infrastructure investment’ (SFT 2009b, 8). This objective should
be conducted in all its activities.

Service innovation

The SFT is involved in asset management, the management of opera-


tional PFI/PPP projects, provision of low-carbon energy, program and
support assurance and arrangement of funding and finance. It has
developed a national strategy for delivery and funding of schools, waste
management and flood prevention. It has also facilitated investment in
health, housing and transport.
In the areas of higher and further education, the SFT developed
sector-specific delivery and funding strategies aiming to lever in more
private sector investment in order to deal with long-term problems
related to the backlog of investment. As already noted, by learning key
lessons from previous PFI/PPP contracts, it is also expected that the SFT
will be able to reduce the costs of existing PFI/PPPs and maximize the
benefit to the public purse.
The SFT’s annual report for 2010 (SFT 2010a, 2) emphasizes two par-
ticular examples of innovative approaches. First, during 2009–2010, the
SFT was managing the delivery of the £1.25 billion ‘Scotland’s Schools
for the Future’ program. Following the completion of a Lessons Learnt
exercise, which reviewed school designs across Scotland, the SFT started
the first school building project. It has also developed an innovative
joint education pilot project between East Renfrewshire and Midlothian
local governments.
Second, the SFT delivers pathfinder ‘hub’ projects designed to break
away from silo-thinking and promote joint working. Hub South East is
116 Organizational Innovation in Public Services

based on collaboration with local authorities, NHS boards, other pub-


lic bodies and private sector partners. Other hubs include hub North
and hub East Central, with hub West and hub South West expected to
follow. These five hubs will increasingly coordinate new and existing
infrastructure for Scotland’s local authorities, health authorities and
other public sector organizations. Considering the expected 35% fall in
infrastructure funding over the next few years, the capability developed
by the SFT will play a vital strategic role (SFT 2011d).
The SFT is also the first body promoting a new model for inter-
authority governance arrangements considering investment needs on
a program (rather than project) basis in order to produce cost-effective
outputs. This means working with most (if not all) public sector organi-
zations with infrastructure delivery and asset management responsi-
bilities, not just local authorities and health boards but also delivery
agencies, government companies, the Scottish Funding Council for uni-
versities and colleges, government directorates for housing and health,
advisory bodies, collaborative procurement bodies (including Scotland
Excel) and local authority joint venture and subsidiary companies. For
example, the SFT is creating joint ventures with local authority develop-
ment companies for asset-backed regeneration.
Therefore, at a conceptual and policy level, the SFT has a mandate to
produce creative innovative solutions and new operating relationships
between stakeholders. It is strategically placed to broker such innova-
tive relationships and exchanges between bodies with a broad range of
relevant experience, to retain and share skills across the public sector.
However, the emphasis on aggregation and collaboration in infrastruc-
ture planning, procurement, financing and management creates new
challenges and risks.
As a part of public scrutiny and diligence, the SFT is required to con-
duct reviews and ensure that appropriate planning has been carried out.
Emphasis is placed on reviewing risks to ensure they are appropriately and
actively managed (SFT 2009b, 13). While the SFT is in charge of the gov-
ernance of risk and its escalation from project to program level, its man-
agement role is more implicit than explicit in the guidance documents.
Following a slow start, during 2009–2010 the SFT became actively
involved in service procurement and at the end of the 2009–2010 finan-
cial year was responsible for a £5.5 billion infrastructure program (SFT
2010a). A £200 million community health program commenced across
Scotland in late 2010, beginning with the new Wester Hailes ‘Healthy
Living Centre’ in Edinburgh. Other health projects include health
centers in Galashields, Lauder Dunscore, Dalbeattie, Glenwood and
Procurement Innovation: The Scottish Futures Trust 117

the Gorbals. The total funding for this program is £2 billion, of which
£1.1 billion will come from traditional capital finance and £750 million
through NPD. Approval has also been sought for NPD funding for North
Ayrshire Community Hospital, the Royal Hospital for Sick Children in
Edinburgh, Dumfries and Galloway Royal Infirmary and the Balfour
Hospital in Orkney (For Argyll 2011).
The Independent Budget Review 2010 highlighted the need to
focus limited capital resources on key priority areas and suggested the
government should enhance further the role of the SFT (The Scottish
Government 2010, 129). Since 2010, the use of TIF has been promoted
to unlock infrastructure investment for major regeneration schemes.
As noted above, to finance projects, money is borrowed against a pre-
dicted increase in locally collected business taxes anticipated by the new
development being created. The City of Edinburgh Council was the first
local authority in the UK to pilot TIF in the £84 million regeneration
of Edinburgh’s waterfront. Other councils followed with proposals for
their own TIF schemes.
Additionally, to provide affordable housing and stimulate the Scottish
housing industry the SFT developed the National Housing Trust (NHT).
There is also a series of large long-term transport projects in partner-
ship with Transport Scotland, including the Borders Rail and Forth
Replacement Crossing projects. The waste treatment sector also presents
major challenges for Scotland in meeting the statutory European targets,
apart from the increasing costs of waste collection and disposal. The
SFT works with project teams across Scotland responsible for delivering
around £500 million of waste management infrastructure (SFT 2010a).
To deliver improved VFM, the SFT draws on European funds, including
JESSICA,1 which is a European Investment Bank fund used to support
urban regeneration capital projects that are not commercially viable or
are considered too risky by the private sector (Audit Scotland 2008).
While the 2010 Independent Budget Review fully endorsed the SFT
approach to service innovation (The Scottish Government 2010), its
recommendations focused on developing further innovative financ-
ing methods for infrastructure investment. So far, the main financing
method at the heart of the SFT is still the NPD model.

The non-profit distribution model

The NPD model was developed in response to criticism of the PFI/PPP


model allowing ‘excessive’ profits (Asenova and Beck, 2010; Toms et al.
2011; Asenova et al. 2010). Although the NPD is not a ‘not for profit’
118 Organizational Innovation in Public Services

model, it has been designed primarily to eliminate ‘excessive’ rates of


return to private sector providers of public sector infrastructure. Under
NPD, private sector contractors and other funders provide loans rather
than equity and receive ‘normal’ market rates of return, which are
capped at the point of signing the contract. Any surpluses made by the
SPV above this ‘normal’ rate are passed to a charitable company and
distributed back to the community, rather than being paid as dividends
to the SPV members (Hellowell and Pollock 2009; SFT 2011a). Apart
from this difference, the governance structure and the contractual rela-
tionships of NPD and PFI/PPP are very similar. Table 7.1 summarizes the
main similarities and differences.
On the basis of HM Treasury PFI/PPP standard documentation, the
SFT has produced a standard NPD project agreement for health and

Table 7.1 Similarities and differences between the standard PFI/PPP and the
NPD model

PFI/PPP NPD

Similarities Governance structure


Contractual arrangements
Patterns of risk allocation
Relatively stable technologies
Whole life-cycle costing
Life-cycle facilities management
VFM requirement
Differences No limit on private sector profit Capped private sector profit
Performance encouraged through Performance encouraged
profit motivation through a combination of
incentives and penalties
Funded through senior debt, No equity receiving
subordinated debt and equity distributed profits
No public sector input into the Public Interest Director
SPV decision making participates in the SPV
decision making
The equity component can All risks are managed in
absorb some project risks the absence of equity
No private sector profits are That part of private sector
returned to the local profits above the capped
communities level is returned to local
communities
Level of community involvement Potentially higher level of
can vary but is usually minimal community involvement
Procurement Innovation: The Scottish Futures Trust 119

education projects that can be used for other sectors such as transport
(SFT 2011c). The implementation of the NPD model is at a relatively
early stage, there being only seven signed contracts compared with
a total of 88 PFI/PPP contracts (The Scottish Government 2011). In
December 2011, the SFT reported a pipeline of £2.5 billion planned NPD
projects in the areas of education, health and transport (SFT 2011b). Two
educational NPD projects will provide new campuses for City of Glasgow
College (£200 million) and the Inverness College (£51 million), both
funded by the Scottish Funding Council (Holyrood magazine 2011).
While in NPD projects the procuring authority has to fulfill the statu-
tory VFM requirement, the criteria for suitability is very similar to the
tests required for PFI/PPPs. Thus, emphasis is placed on major capital
programs for provision of assets with long-term life spans, whole-life
costing, effective risk allocation and stable technologies.
In the absence of equity, the funding relies on a combination of senior
and junior debt provided by banks and other financial institutions. The
senior bank debt, which usually provides the largest part of the funding
package, takes priority for repayment before other obligations. The jun-
ior finance is frequently provided through subordinated debt although
there may be other arrangements. Its price is akin to the price of equity,
which can lead to a higher average cost of finance (SFT 2011a).
Unlike PFI/PPP, NPD introduces a new governance arrangement, the
SPV board being structured to promote the public interest. Specifically,
the new position of a Public Interest Director provides more active
input from the public sector into the project company’s decision mak-
ing. This director is independently nominated by the SFT and tasked
with monitoring compliance and reviewing opportunities including
cost efficiencies and refinancing. Better performance of the SPV compa-
nies is encouraged through a combination of performance and penalty
incentives, rather than through profit. This means that the subcontrac-
tors who have responsibility to provide services at a specified standard
have to take on an even larger proportion of the project risk. In order
to achieve the off–balance-sheet treatment, councils are required not to
be directly involved in the running of the SPV company.
The SNP government – which as noted earlier, publicly rejected the
standard PFI/PPP – saw NPD as a more politically viable but not neces-
sarily radically different option. Potentially, the NPD can achieve more
socially acceptable outcomes in terms of delivering infrastructure at
lower costs better aligned to local service needs. This has been promoted
by the government as a major innovation (The Scottish Government
2008a) leading to wider participation of community stakeholders in
120 Organizational Innovation in Public Services

the decision-making process as well as possible cost-efficiencies and


productivity gains.
The NPD aims to improve and enhance the traditional PFI/PPP model
while maintaining an efficient risk transfer, so that the focus is on
learning from previous mistakes rather than on introducing a radical
change. This leaves the NPD open to criticism that it is not a sufficiently
different approach to local government procurement (UNISON 2008).
In addition to maintaining an optimum risk allocation, other key ben-
efits of the traditional equity-based PFI/PPP that are retained include,
for example, whole-life costing, life-cycle maintenance and facilities
management, performance-based payments to the private sector and
improved overall service provision.
As noted earlier, optimum risk allocation remains a central pillar of
NPD. Despite the lack of equity capital in these schemes, the client
should, in principle, aim for a level of risk transfer (to the private sec-
tor) similar to the level achieved via standard PFI/PPP. Achievement
of VFM for the duration of the contract means that the contractual
risk distribution should be maintained and evaluated against the cash
flows. Under the NPD model this task is more challenging because all
risks have to be managed in the absence of an equity cushion, and
thus leading to different risk governance arrangements. However, these
arrangements are not developed in detail in the guidance documents.
Considering that dividends can be reduced or not paid at all if profits
are insufficient whereas debt interest cannot be waived, this omission
is important and should be rectified. The procuring authorities, mean-
while, should pay special attention to the long-term sustainability of
contractual risk allocation arrangements as this is crucial for the viabil-
ity of the project.
The introduction of the International Financial Reporting Standard
(IFRS) in 2009 encourages local authorities to explore alternative com-
mercial and financial structures for provision of public service infra-
structures. PFI/PPP projects now being ‘on balance sheet’, the client
can be flexible in terms of selecting the most appropriate level of risk
transfer. On the other hand, if the client wants to reduce the financing
costs (i.e., interest rates on debt), which have increased considerably
following the credit crisis, it can offer an explicit guarantee for a part
of the senior debt, known as ‘supported debt structure’. Due to the risk
of jeopardizing the VFM requirement, this option should be carefully
evaluated. The procuring authority can make capital injections that can
take the form of direct payments, loans, land contributions, credit facili-
ties, and so on. The guidance warns against such payments being made
Procurement Innovation: The Scottish Futures Trust 121

before the successful completion of the construction phase, emphasiz-


ing possible VFM considerations.
To sum up, despite not being radically different from the standard PFI/
PPP model, the NPD model attempts to address some of the former’s well-
documented shortcomings, particularly the ‘excessive’ rates of return
earned by the private sector holders of equity (Audit Scotland 2008). It
is defined by three broad innovative features, including enhanced stake-
holder involvement in the management of projects, no dividend-bearing
equity and capped private sector rates of returns. However, the model
does not go sufficiently far in dealing with issues such as high transac-
tion costs, questionable risk transfer, inadequate market competition
and prolonged and expensive negotiations (Hellowell and Pollock 2009).
Nonetheless, the NPD has considerable potential for better governance
arrangements for promoting the public interest.

Discussion

Despite being a relatively small-size organization in terms of number


of employees,2 the SFT oversees considerable public resources in being
charged with a complex task related to strategy for the provision and
maintenance of public infrastructure in Scotland. Its role is crucially
important in the context of economic downturn and significant
decrease of capital investment (Audit Scotland 2011).
In order to fulfill its strategic functions, the SFT enters into multi-party
networking arrangements with a number of public, private and voluntary
organizations, community groups, collaborative bodies, NHS trusts and
service users. In so doing, the SFT adopts an open-system approach to
public procurement. Although developed over the last half century from
technological and operational research, information technology and
general systems theory, ‘systems thinking’ now has clear implications for
public sector organizational arrangements (Chapman 2004, 19):

Systems thinking, which treats public services as complex adaptive


systems, offers an alternative route to developing solutions and
increasing system performance. . . . Systems thinking is holistic and
deals with complexity by increasing the level of abstraction, rather
than seeking to divide the problem into manageable, but separate,
elements.

A key tenet of the open-system approach in government is that it entails


learning and a departure from the autocratic top-down authoritative
122 Organizational Innovation in Public Services

approach (Chapman 2004, 21). This specifically translates into ongo-


ing learning-based interventions, geared to achieving the desired social
outcomes rather than targets and tasks that have to be performed and
monitored. For the public service domain, this means that the emphasis
should be on the facilities and services, which are vitally important for
the communities. This approach prioritizes improvement of the overall
system performance, as judged by the end users of services rather than
by ministers or civil servants. Thus, the opinions of local communities
should be used as a measure of performance.
The policy-making process should focus on continuing improvement
and collaborative work with a range of partner organizations and other
agencies, rather than control and command. Adopting this approach,
the SFT should continue to establish dynamic arrangements with other
partners and agencies, while looking for ways to continuously improve
and reflect on the environmental challenges. The networking arrange-
ments with multiple agents and stakeholders should be increasingly
based on listening and understanding the end-user needs rather than
on instructing. This is itself an innovative process as it marks a shift of
focus from an institutional service-based approach to a user needs–based
approach to governance. There is considerable further potential in this
innovative governance model, which can be realized when all parties
are actively involved in such a way that responsibility for innova-
tion, improvement and risk is distributed among the wider network of
stakeholders and enabling agencies (Jooste and Scott 2012). Ultimately,
innovation is given a key role in policy implementation, with the focus
on proactively fostering innovation and evaluating its impact.
Nevertheless, introduction of the SFT was initially met with consider-
able skepticism. The response by the Edinburgh Chambers of Commerce
(2008) to the government consultation expressed significant doubts
about the effectiveness of its governance model, accountability struc-
tures and relationships with key stakeholders. This reflected uncertainty
surrounding the role and significance of such a body, the argument
being that the claimed benefits could be achieved through existing
means, including a combination of the newly introduced prudential
code of practice for local government borrowing, effective asset manage-
ment and observance of good practice in public procurement.
The SFT has since been criticized by industry representatives and by the
opposition for its slow start and for the loss of construction industry jobs
(Dinwoodie 2009; E-architect 2008). Excessive consultancy fees (includ-
ing agency fees, seconded and interim staff) being paid during the first
years of operation were met with disapproval (Whitaker 2010). UNISON
Procurement Innovation: The Scottish Futures Trust 123

(2008) described the SFT as yet another expensive quango (Project data
file 2010). There are continuing reports in the media reflecting frustration
in the construction industry in Scotland coupled with further criticism of
the TIF model that it does not deliver on its promises (Bain 2012).
Chapman (2004, 10) argued that ‘the dominant approach to policy
making is [generally] based on mechanistic and reductionist thinking’
that presumes control and predictability, while the reality is much more
complex and requires creative thinking and flexibility. This again calls for a
more adaptive and flexible approach, particularly in dynamic market con-
ditions. Hence, to be successful the SFT should be a learning entity that
does not mechanically transfer knowledge taken from a different context.
Crucially, for the whole process to be successful, the other participating
public and private sector agents should be simultaneously and actively
engaged in such learning.
The SFT has significant potential for learning from national and
international examples. Within the national context, there is the exten-
sive experience gained from the use of traditional procurement and the
PFI/PPP. In an attempt to build on this experience, in June 2011 the
SFT published a review of the operational PFI/PPP and NPD projects
in Scotland (SFT 2011e). The review covered 87 operational projects
and identified opportunities for savings and for achieving better VFM
through improved approaches to contract management. It emphasized
the need for increased collaboration, commercial discipline and devel-
opment of a shared-service approach. Specific recommendations related
to optimizing the scope for services, reviewing risk transfer, sharing best
practice in cross-sector provision and cost reduction for the public sec-
tor through shared administration. Interestingly, as concerns the cost
of finance, the report noted that given the increase of the Public Work
Loan Board (PWLB) borrowing rates, there is not always a strong case for
replacing elements of private finance with PWLB borrowing.
Furthermore, a report entitled ‘Lessons Learned: Scotland’s Newest
Secondary Schools’ (SFT 2010b) analyzed the experience of staff and
pupils in 28 schools from 16 local authorities across the country.
The review was initiated in response to the Scottish government’s
announcement (in 2009) of the next phase of a £1 billion major schools
investment delivered through the SFT. The report identifies 19 common
themes such as air circulation, internal environment, staff and student
spaces, dining areas, community use, and it draws relevant lessons in
relation to each theme. The SFT can take stock of what has been deliv-
ered in terms of the new and recently opened school buildings and what
lessons could be taken forward into the design of future new schools
124 Organizational Innovation in Public Services

(SFT 2010b). Considering the complexity of the task, such a ‘diagnosis’


stage can be used as a starting point for developing increasingly inno-
vative and tailored service solutions. Chapman (2004) highlighted that
in complex systems the relationship between cause and effect can be
uncertain, leading to disagreement on fundamental objectives as differ-
ent parties are concerned with their own objectives. This problem has
occurred in some PFI/PPP and NPD projects.
Within its wide remit, the SFT is in charge of the effective distribution
and management of the total project- and program-level risks as well
as the successful risk communication with all community stakeholders
(SFT 2009b, 13). There is recognition of the intrinsically high level of
risk associated with the SFT’s operations but the risk narrative is rather
limited (SFT 2012):

The main risks relate to recruitment and retention of key staff, main-
taining relationships with public sector bodies, misunderstanding of
SFT’s role and the timing and conditions of funding.

The two most important obstacles to organizational learning are fear


of failure and avoidance of diversity/variety (Chapman 2004), both
of them leading to risk aversion. Considering the predominantly risk-
averse nature of many public sector bodies and the increasing recogni-
tion of the role of public sector risk management,3 it can be argued
that the SFT should become more engaged with risk. For example, it
should provide more comprehensive guidance on risk governance and
management that goes beyond the recommendations for optimum risk
transfer. This should include both specific and standard guidance for
the management of risk in public sector procurement in Scotland. Its
current absence means that issues of risk, governance, accountability,
poor practices or processes may not be considered, reported and acted
upon. Such guidance should reflect the contemporary risk management
thinking, which encourages the development of holistic and creative
solutions. The guidance should also highlight the hidden opportunities
arising in uncertain situations that reflect the positive side of risk or the
‘speculative’ risk domain, typically associated with commercial oppor-
tunities, innovative solutions and improved user outcomes.

Conclusions

The UK set the trend in PFI/PPPs and, over the past 20 years, consecu-
tive governments have been significantly committed to its use for public
Procurement Innovation: The Scottish Futures Trust 125

service procurement and delivery. Having first-mover advantage in this


market, over time, the UK developed considerable expertise, which has
been utilized by countries all over the world.
In Scotland, the SNP rejected the PFI/PPP model, instead creating a new
organizational entity, the SFT, tasked with developing and operational-
izing itself as a policy alternative. Despite its limited capital budget, the
SNP government continues to emphasize its commitment to a continu-
ing capital program planned or delivered by the SFT.
In pursuit of its objective to achieve better VFM in public procure-
ment, the SFT has utilized a capped-profit model (NPD). Initially
intended as a funding and advisory body, the remit of the SFT was
significantly scaled down. Due to its lack of borrowing powers, the SFT
eventually assumed the role of investment/service broker and advisor
(rather than financier) to all parties involved in public service provision.
Within these restricted parameters, the SFT still has highly distinctive
powers with which it can play an instrumental role in public service
provision and instigate innovation and change to public procurement
in terms of both approach and process.
The SFT is the first organization of its kind in Scotland with the
explicit remit to innovate and bring fresh approaches to public procure-
ment by introducing a new way of inter-authority governance, operat-
ing at both project level and program level with the potential to break
down the silo approach to public services. It aims at developing new
operational relationships and creative solutions involving all stakehold-
ers, while acting as an enabling organization and a focal point for a new
type of partnership arrangement. It can be used as an organizational
vehicle for this new arrangement to take place, but the processes them-
selves necessitate a change of culture and a steep learning curve on the
part of the SFT and the other parties involved.
The SFT could lead these innovation-driven change processes, but
its full innovative potential cannot be realized if it acts in isolation.
Operating in increasingly difficult economic conditions from the
start, the role of the SFT is challenging, and it has been criticized for
slow progress, excessive use of public funds and insufficient innova-
tion. If the SFT is to deliver what is expected of it, it has to play a
much more proactive role in stimulating service innovation and new
partnerships.
By adopting an open-system approach and promoting culture change,
the SFT can play a more prominent role in public service restructuring
and fulfill its innovative potential. The economic environment presents
the SFT with challenges but also with the opportunity to lead the
126 Organizational Innovation in Public Services

process of restructuring of public services in conditions of austerity and


budget cuts.
As a part of its enabling-broker function, the SFT should actively engage
with communities and promote enhanced stakeholder engagement. It
should facilitate wider community empowerment in close collaboration
with NHS boards, local authorities and other public sector bodies and
the private sector and voluntary sector organizations. This will facilitate
the development of a new more efficient outcome-focused model of
public services, tailored toward community needs and priorities.
The NPD model can be used as a platform for new governance arrange-
ments. The new post of a Public Interest Director, presents an opportu-
nity to enhance public value and to drive a more local, user needs–based
approach. The remit of this post can be challenging as the Public Interest
Director sits on the SPV board with other commercial parties that are
required to deliver ‘more services with less funding’, a task that is equally
testing for both public and private sector organizations.
The SFT has been created as a hybrid-type organization based around
one of the PFI/PPP variants, the NPD model, which has been designed
to increase the ability of the public sector to structure capital projects
effectively and improve VFM. At its best, the NPD model builds on this
learning experience in order to address PFI/PPP shortcomings in terms
of excessive profits, lack of community engagement and insufficient
protection of the public interest. Thus, the main innovative potential
of the SFT is related to improved governance arrangements for public
service delivery based on the potential of the NPD model.
The benefits of the NPD model can be realized if the associated risks
are adequately managed, which means that attention should be given
to counteracting the possibility of high transaction costs, to achieve and
maintain adequate level of risk transfer and to realize VFM over each
project’s life time. While the SFT has recognized some risk implications,
so far, it has largely acted in a risk neutral way. In order to become
proactively engaged with risk, it has to develop detailed and up-to-date
guidance on risk transfer and allocation that recognizes both the down-
side and the upside of socioeconomic change and also accounts for the
related risks. By doing so, it can contribute toward a more risk-aware
culture, creating improved risk governance arrangements that promote
the public interest and well-being.
The analysis earlier makes it clear that the SFT encapsulates a range of
innovative ideas and considerable creative potential. Since the evolution
of the idea and the subsequent launch of the SFT, the general economic
outlook, the demand for public services and the risk environment in
Procurement Innovation: The Scottish Futures Trust 127

Scotland have all changed significantly. Considering this wider policy


context, there is a need for service innovation and risk re-evaluation that
may affect some of the parameters of the initial SFT model. If stronger
fiscal autonomy for Scotland (including independence) is introduced
it will lead to new funding opportunities for the Scottish government,
and new sources of risk are thereby likely to emerge, which the Scottish
government may be unwilling to bear for the funding and procurement
of public infrastructure and services.

Notes
1. Joint European Support for Sustainable Development in City Areas.
2. According to the SFT Web site, there are 40 employees including the senior
management (www.scottishfuturestrust.org.uk/people).
3. See for example The Orange Book, Management of Risk – Principles and
Concepts 2004; The Green Book: Appraisal and Evaluation in Central Govern-
ment 2003; HM Treasury The Risk Programme: Improving Government’s Risk
Handling, 2004; HSE Five Steps To Risk Assessment, 2006, and so on.

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8
Outsourcing Public Services:
Process Innovation in Dutch
Municipalities
Alex D. R. Corra and Jacobus de Ridder

Clearing the Decks

Outsourcing by a government agency can loosely be defined as a con-


tractual relation of the agency with an external vendor, in which the
vendor provides activities that are part of the overall business process
of the agency. If one takes a close look at the phenomena indicated by
‘outsourcing’, myriad variations come into view.
First, should outsourcing include all the activities the agency buys, or
should it refer to merely those procured activities that were previously
carried out internally? Bowersox and Closs (1996), for instance, propose
to reserve the term outsourcing for the latter, making it a subcategory in
a larger class of choices called ‘make or buy’ decisions.
Second, should the term ‘outsourcing’ be reserved for buying-in only
those activities that the agency can also do by itself, as Harrison and
Kelley (1993) suggest? It is a worthwhile distinction when one is inter-
ested in studying clear-cut make-or-buy choices. Only in cases where
managers have the ability to actually do the work inside the agency can
one observe the true nature of the make or buy choice (Deavers 1997).
Third, outsourcing may refer to a broad range of contracting activities,
varying from the occasional hiring of a project manager or a few experts
for a specific job to the full-fledged transfer, to an external contractor, of
operational responsibility over a public transport system or a public utility.
Some authors have suggested parcelling up this continuum and use the
term ‘contracting out’ for the latter part of the spectrum (Deavers 1997).
In this chapter, we stay away from such distinctions as they will not
contribute to our line of argument. We will not focus on merely the
ideal type make-or-buy decisions but include all decisions to outsource,
for whatever reason. Our focus is on outsourcing by contracting out.

130
Outsourcing Public Services 131

Contracting out by public agencies as such can hardly be called a


novel phenomenon, much less an innovation. Governments have
always been contracting private entrepreneurs for the provision of spe-
cific items, activities and services. In the United States, one finds a large
number of so called ‘contract cities’ that outsource most if not all of
their municipal services (Prager 2008; Schiesl 1982). Even though out-
sourcing as such is not new, there have been many changes in the prac-
tice of public contracting, especially over the past 30 years, the period
of time that the New Public Management (NPM) wave swept over OECD
territory. NPM has come in many forms and shapes, its roots and ration-
alities are numerous and varied and its accomplishments are of mixed
quality, as one thoughtful comparative overview demonstrates. All this
variety notwithstanding, the core of NPM might well be summed up as:
‘application of market type mechanisms’ (Pollitt and Bouckaert 2011).
Contracting out is one of the foremost of these mechanisms.
Throughout the OECD and beyond, contracting out has become per-
vasive in the execution of public tasks. The services procured by public
agencies tend to be more and more close to what might be called that
core business of public agencies that can be set down as safeguarding
public interests. Public budgeting, the granting of permits and even
maintaining public order are activities that governments buy in the mar-
ket. The reasons given for contracting out specific activities are manifold,
as we will see, but there always is the tension between private provision
and public interest to be dealt with. Public services vary according to the
amount of social justice involved.
Waste collection, an early candidate for outsourcing by municipalities
in many countries, has relatively little to do with equity or nonarbitrary
rule – although even here such public values are not entirely absent.
Enforcement of environmental regulation on the other hand is fraught
with public interest issues. The central question in this contribution is,
how do public agencies maintain control in contractual relations with
private providers of public services? The underlying assumption is that
public agencies will seek the control needed to secure public values asso-
ciated with the public service that is being contracted out.
Our discussion will focus on contracting out by local governments.
Municipalities often have special reasons for acquiring activities and serv-
ices in the market or from other public agencies. They just may be too
small to do it by themselves. Then they may also be compelled by higher
authority to contract out – as was the case in the UK under the Compulsory
Competitive Tendering program introduced in the 1980s (Boyne 1998).
A central element of this program was the introduction of competition
132 Organizational Innovation in Public Services

into service areas that were previously the monopoly of public agencies –
the assumption being that competition would lower costs and enhance
quality. A more general reason local governments can have for contracting
out is the expectation that competition will enhance innovation (Prager
1994; Domberger and Jensen 1997). Under conditions of competitive
tendering, potential providers have an incentive to innovate in order to
stay ahead of competitors, especially if there is focus on innovation at the
demand side (Edquist and Hommen 2000; Edler and Georghiou 2007).
Moreover, public service innovation could be spurred on by bringing in
outsiders with different perspectives, knowledge and skills (Albury 2005).
The presentation of our argument will draw on research we did in
one specific case of outsourcing a public service by municipalities in
a quasi-market: the case of labor market reintegration services in the
Netherlands.1 Labor market reintegration is the more or less compul-
sory support of jobless people (with some support entitlement) to lead
them back into paid occupation. In the Netherlands, municipalities are
responsible for social security administration – including labor market
reintegration. Over the past 8 years, municipal governments have been
outsourcing reintegration activities on a large scale.
This case of contracting out has a few particularities that drew inter-
national attention (Struyven and Steurs 2005; Van Berkel and Van der
Aa 2005). As from 2004, municipalities were obliged by law to contract
out all services. A (quasi-)market for these services had to come into
being almost overnight. This crash program forced municipal agencies
into a steep learning curve concerning outsourcing. Two years later, in
2006, this obligation was repealed. Now municipalities had the choice
whether to produce internally or buy on the market – another chal-
lenge. The case highlights something known from numerous studies:
innovations such as systematic outsourcing of a public service do not
come easy. Indeed, the nitty-gritty of its implementation is much less
glamorous than lofty NPM recommendations such as ‘steering, not row-
ing’ might suggest. Indeed it is trial and error, coping with conflicting
demands and interests and dealing with complicating regulations. While
doing so, the Dutch municipalities were in a way reinventing contrac-
tual governance. Starting from a simple straightforward approach, they
became more and more sophisticated in dealing with their vendors so
that they actually got what they bargained for.

Modelling contracting out

We highlight core issues a public agency2 is confronted with when


embarking on a new outsourcing policy. One can find a number of
Outsourcing Public Services 133

different ways to model the process, such as the time-line chart devel-
oped by O’Looney (1998) that contains three dozen stops. We start
with a simpler framework put forward by Brown, Potoski and Van Slyke
(2006). In the first stage the agency is pondering whether or not to con-
tract out some specific activity. Once a decision in favor of outsourcing
has been taken, a second stage starts during which a contractual relation
with a vendor is developed and forged. The agency is making choices
concerning the specifications of the transaction in the contract and
concerning the selection of a vendor. During the third stage, that starts
after a deal is closed, the contract is being executed. The vendor will
be providing the services bought, and the agency will be managing the
contract: making choices about the kind and the amount of monitoring
of the delivery process and perhaps also about the kind of interventions
to be applied if the delivery falls short of contractual expectations.

Service characteristics
The more complex the service, the more difficult it is to define and
measure outcomes of the service and to disentangle short-term results
and long-term outcomes (Deakin and Walsh 1996; Van Slyke 2003; Van
Genugten 2008). Thus the results of trash collection are more quan-
tifiable and measurable than those of most social services (Panet and
Trebilcock 1998; Van Slyke 2003). Reintegration services are inherently
complex because they need to deal with a large variety of factors that
may be obstacles on the client’s road to employment.

The institutional context


The institutional context consists of both the legal framework and the
policies that govern service delivery. Legal factors will for instance deter-
mine the discretionary powers for contracting that the public agency
has, while policies that are in place might – inter alia – stipulate service
goals. Specific legislative areas (contract law, administrative law, pro-
curement legislation) will contain regulations that limit or augment the
choices of the public agency in the outsourcing process. In particular
the EU procurement regulations for public agencies (intended to create
a level playing field for public contracting in all of the Union) tend to
influence the options and alternatives an agency has at its disposal.

Market characteristics
A core argument is that the disciplining forces of the market (compe-
tition in particular) will enhance efficiency, innovation and quality
(Domberger and Jensen 1997; Jensen and Stonecash 2005). There should
be a sufficient number of suppliers and buyers or, at least, the market
134 Organizational Innovation in Public Services

should be highly contestable, meaning new suppliers can easily enter


it. Preferably information about the quality of the vendors and their
products is also readily accessible.
Numbers of suppliers, numbers of purchasers and the degree of trans-
parency are three key variables that characterize real-world markets.
Many latter day public service markets have the additional character-
istic of the quasi-market (Bartlett and Le Grand 1993; Lowery 1998;
Kähkönen 2004). A key feature of such a market is that the public
agency buys services to be delivered by the vendor to a third party (e.g.,
a patient or an unemployed person being trained in job skills). This
implies that the buyer cannot make first-hand appraisals of the per-
formance of the provider and thus a quasi-market structure may amplify
the information asymmetry between principal and agent. All these
market characteristics are likely to be relevant for the choices available
during the outsourcing process.

Resources and capacity available for contracting


The resources and capacities that the outsourcing public agency has
available may vary in kind and in amount but are scarce by definition.
This basic notion is a cornerstone of one of the foremost economic
theories of contracting, the principal – agent theory (Eisenhardt 1989;
Laffont and Martimort 2001). According to this theory the outsourcing
party, the principal, will invest its resources in specification, selection,
monitoring and enforcing to the extent that such investments will
equal its returns in terms of service qualities delivered by the vendor,
the agent. In real-life outsourcing processes, the choices of a public
agency may diverge considerably from this ideal type. Nevertheless, the
amount and quality of resources available will influence the choices the
outsourcing public agency makes. One plausible assumption concern-
ing this factor: the more experience and knowledge about contracting
the public agency has at his disposal, the more likely it is that deliveries
will be in accordance with his goals. Another assumption is the more
expertise about the procured service the public agency has available in-
house, the more successful the agency can be in effectively supervising
the contractor (Milward and Provan 2000; Peat and Costley 2001).

Make or buy

Why would a public agency such as a municipal government decide to


outsource the provision of public services? The most straightforward
answer goes back to Coase (1937). Firms will outsource if and to the
Outsourcing Public Services 135

extent that the transaction costs of outsourcing are less than the organi-
zation’s costs of in-house production. Transaction costs may include
the costs of selecting vendors, writing contracts, monitoring and taking
action when deliveries go wrong. Organizational costs are all the costs
the public agency makes to ascertain that members of the organization
act in the interest of the organization. They may include costs of train-
ing and socialization of personnel as well as costs of coordination and
supervision (monitoring members). Indeed, socialization is in many
cases the single most efficient organization tool available (Simon 1957;
Perrow 1972; Ghoshal and Moran 1996a).
Even though the Coasian transaction cost approach is theoretically
sound for explanatory purposes (Hart et al. 1997), it is far from a readily
available device for make-or-buy choices (Ghoshal 2005). The empirical
literature shows that it takes a lot of organizational learning to shift from
‘rowing to steering’. Contract governance is a discipline all by itself. The
more public agencies develop their contract management capacities, the
more they do indeed outsource (Warner and Hefetz 2004; Fernandez
et al. 2008). Even then, the public agency often finds it difficult to make
the comparison between organizational costs and transaction costs, if
only because hard data on both are lacking. If some kind of assessment
is made, indirect approaches are more feasible. Thus, the (limitations in)
the capacity of the buyer to produce the service in-house will weigh
heavily. Another consideration is the nature of the market, more par-
ticularly whether suitable providers are at hand (Domberger and Jensen
1997; Brown and Potoski 2003).
In many cases, arguments other than those derived from rational
administration have been or are paramount. Political beliefs about the
blessings of market type mechanisms or about downsizing government
may directly or through legislation predetermine the decision to out-
source (Fernandez et al. 2008). The outsourcing agency will then have
to make do with the given situation, even though the circumstances
(market conditions, product characteristics etc.) may be far from favo-
rable for efficient contracting (Brown et al. 2006).
As mentioned before, for two years Dutch municipalities were required
by law to contract out reintegration services. In the beginning, there
was not a real market of providers to speak of. Most local governments
had limited outsourcing capacity. Local agencies developed a number of
coping strategies to deal with the situation. One strategy – applied by
about one third of the local governments in our sample – was to contract
out to existing or newly created semiautonomous3 municipal agencies.
These agencies are created by a municipal statute or by a memorandum
136 Organizational Innovation in Public Services

of association that gives its governing board a considerable amount


of legal autonomy toward the municipal government. Buying services
from its own autonomous agency was considered to be in compliance
with the outsourcing obligation. A second strategy was engaging a pri-
vate provider who could be considered trustworthy. Initially, however,
most municipal agencies that turned to the market for services used the
straightforward approach of a public tendering.
The Dutch case shows that the make-or-buy phase offers more choices
than just the one between in-house production and contracting out.
Initially, most municipalities bought in bulk, purchasing up to a few
hundred reintegration trajectories in a contract. During the first cycle
of outsourcing, they learned from experience that this was not neces-
sarily the most effective approach to contracting out. It turned out
that buying in bulk made it difficult to control quality. The municipal
agency often could not acquire an adequate overview of what was hap-
pening with the clients. Problems occurring during the implementation
of trajectories were detected far too late. The purchasing of large lots
of complete service trajectories occurred until around 2007. In later
cycles municipalities shifted to modular procurement: buying the build-
ing blocks rather than the whole process of the employment service
trajectory. The provision of building blocks was outsourced to separate
vendors, while the municipal agency retained the coordinating and
managing of the process. Modular buying made it easier to control serv-
ice delivery. Beyond that, it guaranteed a chain of public accountability,
since public employees (case managers) remained in overall charge of
service delivery and bore direct responsibility for the most sensitive ele-
ments of the reintegration trajectory such as allocation decisions.
Once the compulsory outsourcing was lifted, municipalities were free
to return to in-house provision. Indeed, over the years there was a size-
able increase in the number of activities that municipalities chose to
produce in-house. This return to in-house production was in large part
motivated by the conviction that the municipal agency itself was in a
much better position to produce certain elements of employment serv-
ices than private agencies. The municipal agencies usually cultivated
a large local network of potential employers and were in a position to
forge long-term commitments with local businesses. Private vendors,
on the other hand, usually operated nationwide – or at least on a
regional scale – and often did not have that vested local network that
the municipal agency built over time. Private providers typically needed
to build up such an infrastructure and were not always willing to make
the long-term investments required for developing such networks.
Outsourcing Public Services 137

A second reason for reducing outsourcing was to regain control


over outcomes: the quality and sustainability of the jobs that clients
acquired. If necessary, the municipal agency could provide the client
with follow-up support.
Considering the compelling reasons for in-house production, one
might wonder why municipalities kept outsourcing a large share of
their integration activities. One reason is: lack of capacity and especially
lack of specialized expertise. Furthermore, municipal agencies expected
to buy innovation. Lastly, municipal agencies found that tendering at
least part of the activities was instrumental in keeping the municipal
organization or the autonomous municipal service provider focused
and competitive.

Building the contract

The two centerpieces of this phase are selecting the vendor and writing
the contract. These two activities are not necessarily consecutive. In
open tender procedures, however, most if not all of the contract is writ-
ten before the bidding starts. Even though many public agencies would
prefer to select the vendor before writing a detailed contract, procure-
ment law (such as the Dutch and EU regulation) may be prohibitive.
Alterations in a contract after the tender is closed and after the vendor
has been contracted may even result in claims from competitors for nul-
lification of the contract.
The central choice, when writing the contract and selecting the ven-
dor, concerns the degree of specification and elaboration to be applied.
In any contractual relation, the principal (the party purchasing) is con-
fronted with some uncertainty about the future behavior of the agent
(the vendor). Of course the principal will expect the agent to act and
deliver according to the wishes of the principal. The agent, however,
may diverge from those wishes for any number of reasons. There can
be misunderstandings about the exact preferences of the principal; the
agent may earnestly come to the conclusion that another solution than
the one originally agreed upon is better, and so on. For the principal, it
is not necessarily easy to discover divergences. Hard core principal agent
theory is based on the assumption that the principal will always be less
informed about the actions of the agent and about the quality of the
deliveries than the agent itself. The agent then can (and will) use this
information asymmetry to further his own interests ‘with guile’ as the
famous expression goes – at the expense of the principal (Williamson
1979; Van Slyke 2006).
138 Organizational Innovation in Public Services

The most important concern the principal therefore has (or should
have4) is to design contractual relations that minimize cheating on the
part of the agent. We know from empirical research (Macaulay 1963;
Arrighetti et al. 1997) that such opportunistic behavior on the part of
agents is much less rampant than the theory would suggest. Yet even if
one discards the strong assumptions about opportunism (Ghoshal and
Moran 1996a; Williamson 1996; Ghoshal and Moran 1996b) lots of
potential impediments between the principal’s wishes and the agent’s
actions are left. Therefore, making sure that he gets what he wants is
arguably the principal’s central concern. In designing the governance
of the contractual relationship, two options loom large: building on
formalization and building on trust.
‘Building on formalization’ means that the details of the transaction
are made explicit and put in writing in documents that are binding for
both parties. Formalization thus has two meanings: it is a process as
much as a result (Vlaar et al. 2006; Simon 1978). As a process, formaliza-
tion contributes to ‘making sense’ of what parties will agree to, by pro-
moting articulation, deliberation and reflection and reducing judgment
errors and individual biases. The results, as laid down in one of more
contractual documents, may contain, among other things, the perform-
ances expected from the agent, the specification of the discretion of the
agent, a prescription of the actions parties must undertake in specific
situations, the structuring of the interaction between principal and
agent and the stipulation of prerogatives of the principal. Even though
parties can strive for as much specification as possible, contracts neces-
sarily are incomplete: it is just impossible to know all possible future
worlds (Hart and Moore 1999). An unspecified residue of uncertainty
will always remain.
Formalization poses a number of issues the principal will have to deal
with. Foremost, formalization is costly. As a rule, the more detailed the
contract, the higher the transaction costs will be. Also, formalization
can result in contractual structures that stifle the agent’s flexibility and
creativity needed to find innovative solutions to existing problems.
Furthermore, overformalization can crowd out intrinsic motivation
(Deakin et al. 1994; Frey and Oberholzer-Gee 1997; Frey and Jegen
2001).
‘Building on trust’ means that the contractual relationship is based on
positive expectations about the behavior of the other party. In particu-
lar, the principal assumes that the agent will of its own accord act in the
best interests of the principal: so-called ‘stewardship’ (Van Slyke 2006;
Davis et al. 1997). Theoretically, justified trust will save the principal a
Outsourcing Public Services 139

lot of effort in specifying the contractual relationship and in monitor-


ing and intervening during the contract period (Fernandez 2009). The
catch here is, when is trust justified? In organizations, stewardship can
be fostered through socialization. In contractual relations the tools of
socialization are much less readily available. Trust in contractual rela-
tions builds up over time and has to be earned by the agent, either
through direct relationships or indirectly by reputation. Trust can grow
when mutual expectations about behavior are met. The more relations
are prolonged and the more opportunities there are for expectations to
be met, the likelyhood of this occurring also increases (Parkhe 1993).
Just like building on formalization, building on trust does not offer
complete certainty. Indeed there is an inherent risk in ‘trust in trust’
since trust can be violated (Deakin et al. 1994, 17).
On the basis of the previous account, trust and formalization might
be perceived to be inversely associated. Several factors mitigate the use
of either or both – such as the stage of development of the contract rela-
tion, the properties of the services contracted for and the like (Van Slyke
2006). Empirical studies suggest that high levels of trust between public
managers and contractors do not necessarily lead to less monitoring,
and that trust has a larger positive impact on contract performance than
the instruments from the formalization toolkit (Fernandez 2009).
In the case of Dutch reintegration services, municipalities initially
took a very formal approach to contracting out. They wrote extensive
tender requests, stipulating all requirements and condition to the full-
est. Selection criteria were simple and straightforward: the contract was
awarded to the lowest bidder with the best service quality. However,
because it turned out to be difficult to make strong assessments of future
service quality, bidders could often only be compared on the price for
which they offered the service. As mentioned before, the first cycle of
outsourcing was very much a learning phase. In later cycles, munici-
pal agencies started to experiment with other ways of contracting. We
already mentioned modular buying. Agencies also attempted to limit
contractual specifications and opt for stewardship contracts instead.
Selection procedures that attempt a thorough assessment of poten-
tial contractors themselves are relatively costly. Still, there might be a
trade-off between ex ante costs associated with running a selection and
bidding procedure, and the ex post costs associated with monitoring.
Especially, if the selection procedure aims for a trustworthy provider
who is likely to honor contractual arrangements, costs of managing the
contract may be limited. In order to select a reliable steward, the public
agency needs valid indicators for assessing trustworthiness. Ordinarily,
140 Organizational Innovation in Public Services

past experience of the agency and reputation can be considered valid


indicators. Alternately the principal could apply the criterion of what
is called ‘value congruency’: the provider-to-be has to share relevant
values and norms with the public agency. Some of the Dutch municipal
agencies reported that they were very successful in working with con-
tractors that had stewardship as their core value.
However, under strict procurement regulation, trust is not easily appli-
cable as a selection criterion. Procurement rules may, because of their
focus on objectivity, induce the commissioning public agency to adopt
overly rigid or simplified selection criteria which do not adequately repre-
sent the qualities sought for. In tender procedures with a strong focus on
objectivity something as subjective as trustworthiness or value congru-
ency might well turn out to be nonapplicable.
Another experimental change that spread widely after a while was the
transformation of the terms of the contracts from buying outcomes to
buying processes. In the initial years of contracting out, contracts prima-
rily defined outcomes and contained only a few process requirements.
After the initial cycle of outsourcing, municipal agencies increasingly
wrote process requirements into the contracts and rewrote outcomes as
processes. Municipalities turned from buying ‘outcomes’ (placements)
toward buying ‘processes’ (parts of trajectories). The increased emphasis
on follow-up support was characteristic for this change.
At the same time, the discretion of the providers was also reduced.
Instead, the decision-making, coordinating and day-to-day manage-
ment of service delivery was left with the public agency, namely the case
managers. Indeed, the contract provisions strongly limited operational
leeway of providers by prescribing specific service delivery processes.
However, the reduction of the discretion of the vendors varied with the
type of service being purchased and with the particular provider. Latitude
was greater for services where quality was not of paramount importance
for client welfare. Reliable providers with a good track record would on
average be given a lot of latitude.

Managing the contract relation

Contract management mainly consists of two activities: monitoring


(gathering information and assessing the provider’s performance and
quality of service) and supervision (controlling, correcting and influenc-
ing the provider regarding his performance in service delivery).
Theoretically, monitoring is all that the principal can and will do to
reduce information asymmetry. Practically, monitoring activities have
Outsourcing Public Services 141

a double function. On the one hand, they provide the public agency
with (reliable) information about the provider’s performance and, on
the other hand, the mere act of gathering information operates as an
incentive for the provider to keep up performance as it experiences that
its performance is being observed. Monitoring activities can take many
different forms (e.g., external surveillance, internal self-monitoring or
some hybrid arrangement), which almost all have specific benefits and
drawbacks (Brown and Potoski 2006; de Ridder 1988). Information about
service delivery can be acquired through direct observation, experience,
inspection or field audits. While these types of information gathering
are relatively expensive (as compared to reporting by the vendor itself)
they do tend to offer richer information about agent performance. Also,
this type of information is more easily put into context (Lengel and Daft
1989). Alternately, information about service delivery can be acquired
by self-reporting: progress reports, review of performance data or client
records that are supplied by vendors. Clearly, this type of information
gathering is much less costly. Still it is evident that information from
such self-reporting is less reliable. If the public agency is wholly depend-
ent on the vendor for performance information, there is a strong risk
involved – the vendor may have an interest in misrepresenting its own
performance.
Supervising the service provider requires that representatives of the
public agency interact with employees of the vendor in order to con-
trol and influence performance. There are different styles of supervi-
sion, varying from hands-on management of the service provider to a
kind of management by exception – remaining aloof unless there is a
clear call for intervention. Hands on management can come close to
a hierarchical approach of direct command and control. Such hierar-
chy is routinely applied in high cost–high risk contractual operations
(Stinchcombe 1985). The hands-off approach resembles the ideal type
of market interactions in which the agent is given freedom to act and is
accountable only for the results delivered. Monitoring and supervision
are closely intertwined. In order to supervise efficiently the principal
must have sufficient and reliable information about the agent’s perform-
ance. At the same time, monitoring can be the first stage of supervision.
Together monitoring and supervision can be more or less strict (Faems
et al. 2008).
Factors that tend to influence the choices made regarding monitoring
and supervision are: service characteristics (particularly the measur-
ability of the services) and the contract management capacity of the
public agency. Services that are hard to measure combined with an
142 Organizational Innovation in Public Services

underdeveloped management capacity can considerably drive up the


costs of managing the contract. Of course, here too the alternative of a
stewardship contract may be a solution. Trust limits the need for super-
vision. Results from empirical research under local governments in the
USA indicate that ex ante assessment of potential suppliers and ex post
monitoring of the contractor’s performance generally have little effect
on overall contract performance. Trust on the other hand correlates
fairly strongly with good contract performance (Fernandez 2009).
Most municipal agencies in our sample applied a specific trust strategy –
a strategy that is documented in the literature about contractual rela-
tions (Faems et al. 2008; Lamothe and Lamothe 2012). In the beginning
of a contractual relation, the municipal agency would enforce contrac-
tual compliance quite strictly in order to convey to new providers the
importance of particular service requirements. Subsequently, when a
service provider had proven itself reliable in meeting the agreed terms
of the contract, the municipal agency would award it more operational
leeway so that providers could more easily adapt services to changing
circumstances.
Municipalities experienced considerable difficulty in reducing the
information asymmetry regarding provider performance. Initially this
was inherent to the hands off approach of the municipalities: during
the first contract cycle, providers were required to report only once
every six months and performance evaluation occurred almost totally
ex post. Subsequently, municipalities started to ‘beef up’ monitoring
efforts, requiring more information to be delivered more frequently.
Also they began expanding their own monitoring capacity by invest-
ing in personnel assigned to managing contract relations. Nonetheless,
most municipalities in our study felt they had not been able to acquire a
really comprehensive and accurate overview of how services were deliv-
ered. The most noteworthy solution that all municipalities adopted
was the matching of clients with case managers. Initially clients would
be matched with a specific case manager that would stay with them
throughout the whole service trajectory. Later municipalities switched
to linking case managers to particular providers instead of linking case
managers to particular clients.
This innovative approach had two advantages. First, case managers
were able to maintain an overview of all the clients placed with a par-
ticular provider. This allowed them to gain more insight in the effec-
tiveness of specific providers: they could spot recurring and structural
problems of underperformance. In the process, case managers were
better informed about the specific services that the providers on their
Outsourcing Public Services 143

account should deliver and thus could more easily assess if a client had
received the agreed services. Second, the linking of case managers to
particular providers prompted higher levels of compliance with less
need for explicit enforcement. The prospect of repeated interpersonal
interaction would foster stronger personal bonds that in turn made the
individuals involved try harder to meet the expectations of their coun-
terparts. The pairing of case managers and providers thus comes with a
prospect of future repeated interaction that can act as a proving ground
for the development of trust.

Conclusions

During the five-year period covered by our research project the nine
municipalities developed a number of strategies to ascertain that serv-
ices were procured and delivered according to the demands of the
local government. In doing so they created a succession of incremental
innovations in contract governance. Deconstruction of reintegration
trajectories into smaller modules ranks as the most viable of the strate-
gies developed on the way. Apparently, a careful reconsideration, during
the make-or-buy decision, of what a task to be outsourced really entails
appears to pay off.
A second strategy is the use of ‘trust’ as the basis for contractual gov-
ernance. Building trust relations can help alleviate the transaction costs
associated with monitoring for provider performance. However, trust is
not easy to come by – on the contrary. It ‘comes on foot and leaves on
horse’, as the saying goes. Both building and maintaining trust relations
require careful investments. It takes investments to search for trust-
worthy and reliable agents and investments to develop trust between
contractual parties. Both require an important resource, namely staff
time. Saving on those investments can be done by selecting ‘more insti-
tutionally embedded providers’ as trustworthy partners (Granovetter
1985; Jones et al. 1997). The Dutch municipalities have been doing so
by making use of autonomous municipal service providers.
Procurement regulation, especially the EU law,5 tends to have a strong
constraining effect on efficient outsourcing. It should be noted that
private firms, when contracting out, would never go through all the
motions of a bidding procedure such as that required by EU law for
public outsourcing. Similar effects of the procurement regulations for
the US Federal government are noted in the literature (Fernandez 2009).
In particular, the regulations make it difficult to award stewardship
contracts. Anything that cannot be specified and measured ex ante is
144 Organizational Innovation in Public Services

likely to be inadmissible in a formal tender procedure. Thus procure-


ment regulations can make it difficult to select agents on the basis of
previous experiences.
The linking of case managers and providers is an example of creating
conditions for the development of trust that the municipalities in our
case study widely applied. The building of trust relations is also appar-
ent in the way municipal agencies dealt with contractors over time. In
the first stages of the contract period, they would apply strict enforce-
ment, while determining the trustworthiness of the provider. In later
stages, vendors with proven stewardship qualities would be given more
operational freedom. In this way, municipal agencies optimized the use
of contract management capacities. By investing, in the short run, in
creating personal relations and in socialization; in the long run much
less effort was needed for enforcing compliance.
While contracting out as such may not have been innovative, the
utilization of contracting out did bring innovation to the Dutch
employment services sector. First of all, the obligation to contract out
forced the municipalities to reassess and evaluate what their policies on
delivering employment services actually entailed or should entail. The
large amount of specification of products and processes that needed
to be written into the contract made the municipal agencies rethink
their whole reintegration approach. The second type of innovation was
related to the managing of contractual relations. Dutch municipalities
‘learned by doing’ and adapted their contract management strategies
in order to deal with issues of information asymmetry and uncertainty
about agent performance. They developed their own solutions such as
the modular buying approach to overcome these problems. The third
type of innovation was the development by providers of new service
concepts and innovative products.
Municipal agencies would, after a while, adapt such innovations directly
into their own service organizations. The adoption of specific diagnostic
methods and placement after care services are examples of innovations
that were stimulated or even created by private vendors. Thus even
though the outsourcing of reemployment services itself may not have
led to satisfactory results, the experience did bring innovation into the
design of reemployment services provided by the municipalities.

Notes
1. This particular piece of research was part of a larger five-year research program
under the title ‘Safeguarding public welfare interests under more privatized
Outsourcing Public Services 145

institutional conditions’. The program, conducted at the University of


Groningen, was endowed with a generous grant from Stichting Instituut Gak.
The research we draw on in this paper had contracting out for reintegration
services as its focus. It is a dissertation project within the framework of the
larger program. Data were collected in nine municipal jurisdictions, both
through open interviews and by means of document research. The interviews
were conducted with contract mangers and policy makers of the munici-
palities buying the services and with representatives of service providers.
The document analysis focused on policy documents and contracts used to
acquire the services. This resulted in holistic descriptions of the contractual
governance practices of these local governments. The case descriptions and
their analysis will shortly be published, publication details being available
from the authors.
2. We use “(public or municipal) agency” as a generic term: a part of any public
organization that has at least some autonomy in conducting public affairs or
administering justice. In this chapter, most of the time “agency” will denote
a distinct unit of the municipal organisation charged with social security
administration and/or labour market reintegration.
3. These (semi-)autonomous agencies usually were a continuation of former
departments of the municipal bureaucracy. They were often given the legal
form of a private company, wholly owned by the municipality. At the same
time, they were largely financed by municipal grants.
4. For the normative implications of this principal-agent scheme, see Ghoshal &
Moran (1996).
5. See directives on public procurement 2004/17/EC and 2004/18/EC.

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Part III
Governance of
New Organizational Forms
9
Governance of Public Service
Companies: Australian Cases
and Examples
Anona Armstrong

Introduction

Innovations in the public sector in Australia introduced over the past


20 years have changed the face of government. New Public Management
(NPM), the umbrella term for many of these innovations, introduced
changes in philosophy and practices such as ‘steering not rowing’,
purchaser-provider splits, amalgamations, corporatization, perform-
ance management, and competition and, with them, new forms of
governance and accountability. Globalization, ‘structural gaps’ in public
finances and sovereign bankruptcy threats and the rapid growth of new
information and communications technology (ICT) have again stimu-
lated radical change in the ways in which governments deliver services
and interact with their communities.
The changes orchestrated by NPM frameworks replaced traditional
public sector administration with managerialism and private sector
governance practices, a shift in management from an emphasis on
‘compliance’ to a greater emphasis on planning, control and perform-
ance management and evaluation. The credit-rationed financial envi-
ronment since the 2007–09 credit crunch in the banking sector (and
its transmission to the public finances of many countries) has given
further impetus for organizational innovations to increase efficiency
and productivity.
The purpose of this chapter is to review the governance of some of
these new forms of public sector organizations. In Australia, they include
outsourcing of service provision, Government Business Enterprises
(GBE’s) and State-Owned Enterprises (SOEs), Public-Private Partnerships
(PPPs) and networking.

151
152 Organizational Innovation in Public Services

Governance in the public sector in Australia

Numerous organizations in Australia have issued governance guide-


lines that are applicable to the public sector. Within the country,
widely used corporate governance guidelines include those distributed
by the Australian Auditor-General (Australian National Audit Office
[ANAO] 1999), the NSW Audit Office Corporate Governance Guidelines
(NSW 1997), the Victorian Auditor-General (Cameron 2003) and the
Municipal Association of Victoria and the Victorian Local Government
Association Code of Good Governance for local government (MAV
1997). Every state government has produced its own governance guide-
lines. An example is the recommendations for governance practice in
Victorian state government entities produced by the Victoria State Services
Authority (State of Victoria 2006). Many of the publications followed the
principles identified by the OECD (1999), the International Federation
of Accountants (IFAC 2001) and Standards Australia International (2003;
refer to Armstrong 2004 for a review).
Governance was defined by the ANAO (1999) as:

The processes by which organisations are directed, controlled and


held to account. It encompasses authority, accountability, steward-
ship, leadership, direction and control exercised in the organisation.
For Commonwealth bodies, key elements of corporate governance
include transparency of corporate structures and operations, the
implementation of effective risk management and internal control
systems; the accountability of the board to stakeholders through,
for example, clear and timely disclosure; and responsibility to
society.

Leadership refers to how well a chair and board set the strategic vision
and direction for the entity and added value to its organization. It
relies on clarity about roles and responsibilities and compliance with
ethical and governance standards. Stewardship refers to the structures,
systems and processes for decision-making and control, communica-
tion and financial responsibilities, risk management and compliance.
Accountability addresses standards of behavior and systems in place for
auditing, risk management and reporting procedures such as disclosure,
transparency and the role of audit committees. It also includes the
ways in which relationships are managed with various stakeholders: the
relevant ministers, various partners and external bodies representing
citizens, media and wider society.
Governance of Public Service Companies 153

The major statutory accountability and governance framework for


Commonwealth bodies were presented in the Commonwealth and
Companies (CAC) Act 1997 and the Commonwealth Financial and
Accountability (FMA) Act 1997. ‘Good’ corporate governance was also
defined by the Australian National Audit Office in better practice guides
(1997, 1999). The CAC Act (1997) provisions take into account the ‘pub-
lic interest’ obligations that directors and officers have under the Act but
do not expressly codify ministerial directions, community service obli-
gations and other public accountability mechanisms (Edwards 2002).
While governance principles were well-defined, their application var-
ied across the multiple structures of commonwealth and state public sec-
tor entities. These grew in complexity as all the Australian governments,
the Commonwealth and each of the six states’ governments followed the
path of corporatization. Corporatization refers to the adaption of private
sector commercial principles in the public sector. It was introduced in
stages: First, many traditional internal administrative arrangements,
(payroll, ICT, etc.) were outsourced. Then, many functions – particularly
if they generated funds – were established as GBEs (the term used for
government-owned companies by the Commonwealth government)
and SOEs (used by the state government). Some of these were subse-
quently totally privatized. As governments in the late twentieth and
twentyfirst centuries sought innovative ways of accessing funds and
securing value for money (VfM), they turned to new organizational
arrangements such as PPPs and Networks.

Outsourcing

Outsourcing became popular in the private sector in the 1980s, but it


was when Osborne and Gaebler’s book (1992) stimulated governments to
identify the difference between ‘steering’ and ‘rowing’ that outsourcing,
and then corporatization, became popular in the public sector. This meant
that governments determined what services were required and sought
tenders for the delivery of services. Many services previously delivered by
government were subsequently contracted out, although the government
retained control, a process that became known as the purchaser-provider
split. Contracts were awarded on a competitive basis to internal and exter-
nal private and not-for-profit service providers. The aim was to increase
efficiency by competition between service providers in the public, pri-
vate and non-profit sectors. Effectiveness (defined as meeting ‘customer’
needs or social goals) was to be maintained by contractual obligations.
Performance indicators monitored compliance with those obligations.
154 Organizational Innovation in Public Services

Barrett (2003), the former Australian Auditor-General, believes that


outsourcing of functions offers increased flexibility in service delivery, a
greater focus on outputs and outcomes rather than on inputs and proc-
esses, the freeing of public sector management to focus on higher priority
or ‘core’ activities, encourages suppliers to provide innovative solutions
and cost savings.
Governance issues with outsourcing were essentially about maintain-
ing government control. Barrett (2003, 25) advocated the use of Service
Charters as an ‘element of good governance and part of the account-
ability framework for performance achievement’. Outsourcing shifts
the operation of service delivery to the private sector, but governments
were vulnerable to being seen as accountable for decisions about service
delivery over which they had limited control. The solution appears to
be to shift the whole of an operation and its risks to GBEs.

Government business enterprises

GBEs have always existed in a variety of forms (Wettenhall 2003). By the


end of the 20th century many governments owned massive organiza-
tions, providing services such as transport and other utilities. Although
government owned, many had some autonomy and were operationally
separate from government departments and ministries; however, staff
remained part of the public service.
While competitive tendering increases competition in the provi-
sion of services, governments are still responsible for service delivery.
Furthermore, governments needed to find the finance for upgrading
century-old infrastructure assets, such as trains and trams that close to
being replaced. As governments sought to further unload and escape
from responsibility for such services and to seek additional sources of
revenue, they turned to GBEs that mirrored the governance arrangements
in the private sector. GBEs are structured as separate legal entities and are
required to meet commercial expectations. They may take the form of
either a Commonwealth company limited by shares or a Commonwealth
Statutory Authority.
Although GBEs are prescribed in regulations under the Commonwealth
Authorities and Companies Act 1997 (CAC), their governance is speci-
fied in the GBE Guidelines (Commonwealth of Australia 2011). The
main features are the control by government, expectations of full-cost
recovery, a dividend payment and accountability arrangements. GBE
companies are owned, financed and controlled by government and
usually expected to return an income stream. Examples are as varied as
Governance of Public Service Companies 155

courts, the Murray-Darling Water Commission, the National Broadband


Network and some prisons.
A body corporate established under an Act has perpetual succession
and can sue or be sued. The corporate governance structures for state-
owned companies include separate legal entities status, boards of direc-
tors, private sector auditing and annual reporting. Members of boards are
subject to the same duties and responsibilities as the directors of private
companies. Boards of GBEs must be chaired by an independent director.
Committee structures include audit committees and committees respon-
sible for recommendations on board composition and membership.
Boards can recommend a CEO, but the appointment remains with the
minister. Remuneration is determined by the government’s Remuneration
Tribunal. By 2015, the boards must also comply with the government’s
targets on diversity in their composition: 40% women, 40% men and the
remaining 20% either men or women. The performance of boards, indi-
vidual directors and CEOs are assessed annually. Directors are liable for
the full responsibilities of directors under the Corporations Act and both
civil and criminal penalties apply for breaches.
The Ministry of Finance and Administration generally takes a lead role
in the financial matters related to the enterprises and a portfolio Minister
focuses on portfolio matters. One of the advantages of this arrangement
is that it separates the conflicts of interest that a government typically
has in its dual role as both the owner of an SOE and the representative
of the SOE’s customers. The two ministerial entities are seen to have
competing constituencies that – introduced into the corporate govern-
ance framework – are likely to subject corporate governance to more
rigorous checks and balances than would a single government ministry
(Vagliasindi 2008).
The Australian government’s relationship to its GBEs is similar to
the relationship between a holding company and its subsidiaries.
However, the Commonwealth’s guidelines state that it will not provide
formal guarantees of GBE liabilities. Government control is exercised
by requirements for operations to be in agreement with government
priorities and timely disclosure of information, which may influence
the value of the GBE or government decisions. To enable greater public
accountability, wholly owned GBEs are required to prepare a Statement
of Corporate Intent (SCI) in consultation with the Portfolio Minister.
A SCI focuses on the purpose and corporate outlook of a GBE and
expresses the expectations of its management in relation to future finan-
cial and non-financial performance. Ministerial directions to the entity
must be in writing. The enterprise is accountable to the Parliament via
156 Organizational Innovation in Public Services

the responsible minister. Financial accountability links are established


when the Auditor-General reviews the accounts and reports directly to
parliament upon those accounts.
Among the advantages of corporatization are distancing a govern-
ment from corporate activities and political consequences, should
things go wrong, and in some cases, also providing access to special-
ized skills and expertise and more efficient use of resources. Vagliasindi
(2008, 8) described the potential advantages of corporatization as: ‘The
empirical evidence suggests that by structuring the internal governance
system of SOEs according to that of a modern corporation, corporatisa-
tion may enhance efficiency through better monitoring of managers,
improvements in information-sharing channels, and a reduction in
governmental political intervention. It may also affect the incentives
and objectives of managers by tightly linking enterprise performance
with the evaluation and remuneration of managers’.
Competition is seen to be the answer to producing greater efficiency
and effectiveness. For this reason many government owned GBEs were
fully privatized. Qantas, Aussat, Australian National Line, Telecom,
Australia Post and Australian National Railways were incorporated in
this way. In the states, when transport services were hived off to private
operators, the former monopoly services were divided up and different
operators appointed to different routes. If an operator failed to meet
performance targets, they were penalized. The problem was that when the
operator also failed to make a profit, the situation was compounded by
the penalties, and in some cases the operators collapsed. The government
had to step in and support the enterprise until a new operator was found.
In such circumstances, in the interim period, there would be little incen-
tive for an operator to keep to the required standards of maintenance and
services. This would further lower the value of the asset.
Several issues emerge when applying private sector law to the public
sector. Edwards (2002) noted the distinct differences between the share-
holder/owner and the profit motive in a private sector organization and
a government’s responsibility for perhaps retaining assets, monitoring a
variety of performance outcomes and ensuring that government priori-
ties were implemented in the public interest.
The ‘agency’ problem (Clarke 2004) arises in the private sector from
the fact that owners have handed over control of the company to a board
with a class of professional directors who then are seen to act as agents
of the owners. The separation of owners from control of their companies
raises opportunities for managers to pursue their own interests rather
than those of the owners. Tomasic and Fu (2005, 8) argue that agency
Governance of Public Service Companies 157

problems are likely to be more severe in government-owned enterprises


because government owned corporations have had particular difficulty
in dealing with agency costs unless they are prepared to adopt the kinds
of measure (such as the use of incentives, monitoring and controls) that
help to achieve greater efficiencies in private sector companies. Also,
the fact that the chief executive of a government owned company is
appointed by the government-in-council, means the effectiveness of
the board in being able to sanction poorly performing management is
significantly reduced.
A poorly performing board in the public sector is also to some extent
‘protected’. In the private sector, the threat of bankruptcy poses a strong
incentive to perform well. In the public sector, the political ramifica-
tion of not injecting needed finance into visible community assets is
a stick for both management and state owners. Vagliasindi (2008, 5)
argues that ‘Barriers to exit have insulated the management of SOEs.
Continued state-directed credit, equity injection and finance deficits
have created perverse incentives for managers of SOEs and perpetu-
ated soft-budget constraints’. Experiences over the past few years – for
example with entities such as the State Bank in South Australia (SA),
and more recently the Commonwealth-owned Securency Pty Ltd, the
manufacturer of the new polymer banknote – illustrates how poor
board performance is the result of ineffective boards, lack of asking the
right questions and lack of control over senior management.
Despite the adoption of corporatization, the new structures did not
necessarily lead to generation of the new sources of income that govern-
ments were seeking. To meet these needs, governments turned to the
new managerial doctrines contributing to the development PPPs and a
networked economy.

Public-private partnerships

Perhaps the most innovative shift in service delivery was to PPPs.


National PPP Policy and guidelines for Australian governments were
endorsed by the Council of Australian Governments in 2008 (Australian
Government, Infrastructure Australia 2008). A PPP is a service contract
between the public and the private sector where the government pays the
private sector to deliver infrastructure and related services over the long
term (Victorian Department of Treasury and Finance 2012). In line with
National PPP Policy and Guidelines introduced in 2004, the Australian and
state governments will consider a PPP partnership for any project with a
capital cost in excess of $50 million (Infrastructure Australia 2012).
158 Organizational Innovation in Public Services

PPPs take several forms: Build-Own-Operate-Transfer (BOOT), Design


and Construct (DC), Design Construct and Manage (DCM), Alliancing
and contracts (Mols 2010). The government can engage one party to
design, finance, construct and maintain (and in some cases, operate) a
facility. The contracting entity may be a single entity or a consortium.
The government funds the project only after the facility has commenced
operations. Payments are subject to meeting performance targets, and
contracts include sanctions for nonperformance.
Leading in the uses of PPPs is the State of Victoria, which has used
PPPs in building projects as diverse as hospitals, prisons, a desalina-
tion plant, train stations and road tunnels and links. Under its policy,
Partnerships Victoria (Victorian Department of Treasury and Finance
2001), a contract typically makes the private sector parties that build
public infrastructure financially responsible for its maintenance and
performance throughout the asset’s lifetime. When the Treasury calls
for a response to tender, it uses an interactive online tender process
supervised for probity. The risks are transferred to the private sector
by the commitment of private finance over an extended term. Some
projects, such as the East Link toll road, are now self-funding. Details of
contracts, less the commercially confidential information, are posted on
the Partnerships Victoria Web site.
The benefits of PPPs are said to be access to private sector innova-
tion, commitment to continuous improvement, efficiency and quality,
the transfer of risk and VfM. In contrast, criticisms of PPPS are that the
bidding process commits private sector companies to enormous costs
in preparing competitive responses (hence the $50 million threshold
noted earlier) and the projects are not always VfM. Additional criticisms
are that it takes too long to award contracts and that new local and
overseas bidders for projects face barriers to entry.
In a review of 19 PPP projects awarded by the Queensland govern-
ment, Mols (2010) found that the PPP infrastructure market in Australia
was dominated by two German firms – Hocktief and Bilfinger-Berge,
both with subsidiaries in Australia. These firms either through subsidiar-
ies or by teaming up together have won the lion’s share of all contracts.
Infrastructure Australia in a review of competition and efficiency in the
procurement of PPPs (Mrdak 2010) found that bid costs are on average
around 25 to 45 per cent higher than Canada but less than those in the
UK. The time to procure a contract is 17 months on average, compared
with 16 months in Canada and 34 months in the UK. The biggest
barrier is the relatively small number of PPP projects in Australia com-
pared with Canada or the UK.
Governance of Public Service Companies 159

The estimate of best VfM on major and complex projects is based on


comparison with what the same project could achieve under a more
traditional procurement process. A Public Sector Comparator (PSC) is
used to determine the value for money. The PSC estimates the potential
cost to government of itself providing a facility, and uses this to provide
a benchmark against which bids for the PPP are compared (Fitzgerald
2004). The problem appears to be that the discount rates and other
assumptions underlying the model are unreliable. Whether VfM is
achieved is difficult to establish (Hodge and Greve 2008; 2009), and
Mols (2010, 229) argues that there is ‘a growing body of literature sug-
gesting we are witnessing over-reliance on PPP procurement’.
A Public Accounts and Estimates Committee (PAEC) report (2006)
identified four governance concerns evident in past private funding of
public infrastructure projects: the omission or overriding of community
interests; the ‘lock in’ effect of long-term contracts on future govern-
ments (asymmetric lock-in favors the supplier [Mols 2010]); the lack of
protection for consumers or users who pay for the services, for example,
toll roads and the lack of clarity of contractual obligations. Mols also
raises the issue of conflict of interest within government when large
firms make big donations to both political parties.
In one case of the government being ‘locked in’ to a contract, a change
in the Victorian government in 2010 led to revelations that the cost
overruns of a PPP desalination plant had expanded to $19 billion. There
was an argument promulgated in the newspapers that the desalination
plant was no longer needed because of a break in a ten-year drought,
and the contract should be terminated. The new Premier, Ted Baillieu,
said that breaking the contract would cost several million dollars and
damage Victoria’s reputation (Caldwell 2011). A similar argument was
put in the case of MyKi, a transport ticketing system which, when the
new government took office, was well overdue and over budget.
The contractual obligations are often confusing because of the man-
ner of government requests for tenders. The government ‘bundles’ the
various requirements together so that the entity awarded the contract
may be a consortium of suppliers who may be in partnership or one con-
tractor operating with subcontractors. In a recent PPP arranged to build
and manage a new prison, one of the subcontractors collapsed, putting
the remaining contractors under pressure. The outcomes of this are still
under review at the time of writing (2012).
In respect to the major road construction and toll, ‘CityLink’,
Davidson (2003) argued that the engineering expertise in this major
road toll project could have been accessed by outsourcing and that the
160 Organizational Innovation in Public Services

tolls are twice as high as they would be in the public sector because
the private sector has to pay higher interest rates for capital than the
government would. The Victorian Treasury (2012) refutes this argument
saying that this is not the case, but instead it claims that the costs of
risks are included in the costs of private finance so that taxpayers do
not bear the costs of failures. In contrast, when the risks are borne by
the public sector, and failures (such as La Trobe Hospital PPP) occur,
the government must step in because the PPPs are unprofitable and the
community groundswell requires a political response.
Overall, it appears that successful PPPs are those funded by user pays
financing and the unsuccessful are those operating under government
and private sector funding. However, the infrastructure projects are
delivered. Either they would not otherwise have been built or they
would have been delayed, without the financial arrangements offered
by collaboration in a PPP with the private sector.
The collaboration intended by moving to PPPs raises a number of gov-
ernance issues. It is usually assumed that a registered company incor-
porated under a general incorporation statute will be legally separate
from its shareholders and have a separate management structure. The
company ‘owners’ would only hold shares in the company, but not own
the company property as this is seen to belong to the company alone.
In the public sector, where the state retains ownership, this separation
is not always the case. While the state divests itself of the responsibility
for services (and potential political consequences of nonperformance),
it retains control through its control over future ownership, strategic
direction and accountability.
The OECD (2005) has raised issues about the dangers of potential
abuse of minority shareholders. Minority shareholder rights are to some
extent protected by the disclosure provisions of the Corporations Act
and the listing requirements of the Securities Exchange (ASX 2005).
In PPPs the minority private shareholders do not experience the same
protection.
A central tenet of governance is control and accountability.
Appropriate performance evaluation and monitoring are difficult.
While performance targets can be relatively easily specified, (how
many services delivered, the return per service, the number of trains
arriving on time, etc.), these types of measures fail to capture the
equity issues or social goals that the public sector is expected to
deliver. According to Victorian Auditor-General’s Office (Pearson 2012,
16), many public agencies report performance but only a few report
relevant, appropriate and useful performance measures. For SOEs there
Governance of Public Service Companies 161

is potential conflict between the achievement between a multiplicity


of objectives ranging across government priorities, short-term and
long-term objectives, annual targets, HR targets, financial targets, effi-
ciency and productivity targets and customer service targets. Conflict
is further compounded by the different views about what is a desirable
process or outcome. In the case of implementation of a national com-
munications system, the National Broadband, opinions about the best
type of network to implement divided on political party lines. Which
network and the equity involvement of the government in the entity
appeared to be made on political grounds instead of what should have
been a business decision to meet national needs for communication
technology.
Annual reports are usually audited by the Auditor-General and tabled
in parliament by the responsible minister, at whom the parliament may
direct inquiries. ‘Financial accountability links are established when the
Auditor-General reviews the accounts and reports directly to Parliament
upon those accounts. Social and political accountability links are estab-
lished via the minister and parliamentary scrutiny’ (Guthrie 1993, 104).
However, English (2006, 259) examined the Auditor-General’s over-
sight of PPPs activity in Australian jurisdictions between 1980 and 2006
and reported that out of 127 PPP projects, 121 had not been subject to
independent oversight by Australia’s Auditors-General. NSW had per-
formance audited 8 out of a total of 30 PPP projects; Victoria, 7 of 49
projects; and Western Australia (WA), 1 out of 12. No audits had been
undertaken in Queensland, South Australia or Tasmania. Furthermore,
when a government becomes both the owner and the regulator, as it
can be in a number of areas, it raises a number of governance issues and
potential conflicts of interest.
Several writers (Edwards 2002; Grantham 2005; Tomasic and Fu
2005) have pointed out that ministerial responsibility is an ineffective
accountability device. Grantham has noted that while a minister may
have access to information about an entity’s affairs, the minister may
for political reasons not wish to know about it, or even if he knows
about it, may choose not to do anything about it. In each case, the
minister’s personal interest conflicts with the role of the owner protect-
ing an investment and the role of an agent of government, and as a
result, returns are not maximized for the state.
In response to the above dilemmas, the national guidelines for PPPs
have attempted to establish clear and consistent ownership policies
and to ensure that accountability is carried out in a transparent and
accountable manner.
162 Organizational Innovation in Public Services

Networks

While PPPs are partnerships responding to major projects, another type of


partnership are coalitions of government, public, private and not-for-profit
organizations and local communities. Collaborative arrangements range
from volunteers in community-directed projects, fairly informal and short-
term contracts, to long-term and highly structured forms of cooperation in
alliances, partnerships and joint ventures.
Networks are platforms for alliances and partnership made possible
by the growth in sophistication of ICT. They are composed of nodes and
links. Nodes are organizational units and individual members of organi-
zation. Links represent the connections between the nodes. Horizontal
networking connects functional activities on the same level within
participating organizations. Vertical networks connect different levels of
value. Networking arrangements differ in terms of the duration, struc-
ture and degree of formality that binds the participating organizations
and at different stages in the life of a network relationship. The potential
for networking to increase efficiency has been endorsed by a number
of writers (Lewis 2004; Smith et al. 2006), while others have suggested
that networks strengthen the opportunity for citizen participation and
hence democracy.
In contrast to the competitive models of governance associated with
corporatization, networking assumes some degree of collaboration:
something is done together and assumes mutual benefit, for example
to reduce costs, increase economic efficiency, enhance flexibility, and
achieve better services outcomes. Network governance depends on trust,
loyalty and reciprocity for a network to be successfully developed and
maintained. In contrast to traditional hierarchical or competitive market
forms of governance (Table 9.1), the high degree of network flexibility
for the participants, the low levels of bureaucracy and the opportunities
for speedy implementation of activities favors the adoption of innova-
tive solutions for problems.
The emergence of network governance appears to have been driven,
first, by the emergence of citizen rights and the demands for a voice in
the provision of services that affect a wide range of stakeholders and,
secondly, by the growing focus on coordinating activities across the
‘whole of government’ and with the not-for-profit and private sectors.
The involvement of communities in provision of their services is said
to be capable of producing just, that is, equitable, outcomes which are
in the interests of those affected by the outcomes.
Governance of Public Service Companies 163

Table 9.1 Contrasting forms of governance in the public sector

Traditional hierarchy Market Network

Philosophy Government Competition Collaboration


knows best
Relationship Authority Contract Trust
Structure Pyramid SOEs & GBEs (a) Spider’s web
(b) Partnerships
Accountability Government Auditor-General Stakeholders
department Government
shareholders
Purpose Regulation Efficiency (a) Citizen
participation
(b) Shift financial
burden
Finance Government funded Private Shared revenue
raising
Example Department of Prisons Partnerships
Human Services

The ‘voice’ of citizen stakeholders is facilitated by access to information.


ICT has grown in the past few years, as has the phenomenon of social
media. This, together with a growing sophistication in governments’ use
of ICT, has dramatically changed the relationships of governments with
their constituents, an area that deserves further investigation. Skelcher
et al. (2011, 8) agreed. In their study of the association between gov-
ernance networks and democracy, they concluded that ‘the spread of
networks in public policy making is likely to lead to more substantial
transformation of the democratic processes’.
Often the community voice is heard through their representatives
serving on advisory committees. An example is Victorian Cemetery
Trusts. The governance of the cemeteries trusts is set out in its Act
and cemeteries Good Practice Guidelines. The trusts are incorporated
public entities controlled by a statutory board of six to nine members
appointed or removed by the Governor in Council on the recommenda-
tions of the Minister for Health. Current policy recommends that bodies
such as cemeteries should be representative of the communities they
serve and should seek to appoint women to half of all new appoint-
ments (State of Victoria 2011). Candidates should be assessed according
to a skills-based matrix relevant to the particular trust.
164 Organizational Innovation in Public Services

The governance structures are similar to those applying to all


Victorian public sector entities and SOEs, with some additions. The Act
confirms a role for the community in the governance of the cemetery
trust. It requires a Cemetery trust to appoint at least one Community
Advisory Committee and sets out its appointment, roles and functions.
The cemetery trust must also develop guidelines and performance
indicators for the Community Advisory Committee, and these must
be published on the Internet. A trust’s annual report must also disclose
the results of measures of the effectiveness of its consumer engagement
activities. While the Community Advisory Committee has no legislative
authority and is accountable to the trust, it provides a mechanism for
community engagement in the cemetery trust services and the trust’s
accountability to its community.
In Australia, ‘joined-up government’ and ‘whole of government’
arrangements were introduced within or across departments or ministries
in the 1990s. A common alliance is between the Ministry of Finance and
one of the Service Ministries such as education or health service provi-
sion. The Victorian Department of Treasury and Finance in its Evaluation
Framework (2000) uses both whole-of-government and departmental
evaluation frameworks to provide a means of assessing existing and
ongoing implementation of management reforms. The process aligns
departmental activities with government priorities and reports the extent
to which each department achieves its required performance outputs, the
resources involved and the management of risk. Boards are responsible
for ensuring that there is a financial risk management policy and internal
control system in place, and a financial code of practice.
Several programs requiring multiagency solutions are funded by The
Victorian Department of Planning and Community Development fol-
lowing the release of the policies Moving Forward (State of Victoria 2005)
and A Fairer Victoria (State of Victoria 2006). They address problems such
as transport disadvantage or socioeconomic disadvantage in particular
geographic areas or populations (DVC 2007). Examples (McDonald
et al. 2010; Pope and Lewis 2008) range across a wide spectrum, includ-
ing funding a coalition of indigenous organizations to improve the
social and economic well-being of an aboriginal community and work-
ing with a developer and the local council to try new ways of delivering
infrastructure services to a new housing development.
The governance arrangements are as varied as the projects but have
one thing in common – the partnerships are self-governing and deter-
mine their own processes for operating. Some are held accountable to
the department through performance measures. All members of the
Governance of Public Service Companies 165

partnerships are volunteers. Most partnerships are jointly funded or


supported by a partner in some way. The indigenous project was funded
by federal and state governments, with support from local government.
In most cases, the Victorian government provides support that is in the
form of a ‘broker’. The brokers are critical to the success of the initiatives
because they foster cooperation, assist in navigating the state bureauc-
racy and build the relationships throughout the networks. The success
of partnerships is dependent on the relationship building that ‘allows
people to learn about each other and reshape any stereotype views they
hold’ (Pope and Lewis 2008, 449).
The argument for the superiority of partnerships using network modes
of governance is because of their effectiveness, efficiency, reduction in
transaction costs and that they can help build competitive advantage
(Sorensen and Torfing 2005; Considine and Giguere 2008). However,
collaborative decision-making is costly in terms of time and resources
because of differences in organizational interests, professional agendas
and ways of working, political agendas, the extent of individual and
organizational capacity to engage in dialogue and negotiation, and the
traditional method of budgeting. From a government perspective, there
are the additional tasks of managing the political risks associated with
engaging with stakeholders. To the aforementioned may be added a
requirement for new skills and capacity in the public sector that enable
project management, monitoring and evaluation and management of
social media.

Conclusion

The organizational structures adopted in Australia, namely outsourcing,


GBEs, PPPs and networks, are now complementary to the traditional
hierarchy of government administration. However, the success or other-
wise of these most recent governance innovations is uncertain because
so few systematic evaluations have taken place that there is a scarcity of
assessments of the value of their governance arrangements. At the same
time as corporatization and private sector governance and management
structures are incorporated into the public sector, they reduce govern-
ments’ control of the outcomes and put pressure on governance issues
such as leadership, ethical behavior, government strategy, risk manage-
ment, stakeholder management and the results to be achieved.
In regard to PPPs, the Victorian Auditor-General (PAEC 2006, 89)
stated that ‘key elements of evaluation have not been followed’ and
according to PAEC (2006, 101) ‘there have been few rigorous evaluations
166 Organizational Innovation in Public Services

of the relative effectiveness of actual projects particularly to compare


with the predictions of cost savings and the business cases submitted’.
Newspaper reports are focused on those that have had difficulties. Most
failures or ‘hiccups’ are associated with cost overruns and a disregard of
community voices. Most successful PPPs have been those (such as new
road infrastructure) where the costs of services have been moved to a
user pays system. Nevertheless, from the government’s point of view,
PPPs have provided access to private sector funds and attracted foreign
and local investment in much needed infrastructure. Issues yet to be
resolved relate to transparency of the political influence of the investors
and their use of commercial-in-confidence provisions to restrict access
to information.
Evaluation of networks is difficult because of the diversity of the objec-
tives and intentions of the participants and their governance arrange-
ments. Control by government, and authority and accountability are
diffused. Networks are intended to bring together the resources of a wide
range of stakeholders to meet community needs and give a democratic
voice to the communities. But, are they simply a means of diffusing
community angst? Or, will they be a rallying point for community dis-
satisfaction? And, how effective are they in championing local needs
and how much influence do they have on government priorities?
The financial credit squeeze and uncertainty associated with, and still
lingering from, the global financial crisis is foremost in government
strategies. For this reason, there is likely to be a continuation of the poli-
cies that aim to shift services to the private sector and reduce the risks
to government. The organizational forms that will meet this challenge
are the partnerships, blending of the private, not-for-profit and public
sectors and a yet-to-be-delineated response to the rising demands to be
heard by a new fourth partner, a democratic and community voice.

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10
Governance of Social Enterprises
as Producers of Public Services
Isabel Vidal

Introduction

There is a wide range of partnership relationships between the State


and Third Sector organizations in Europe (Evers and Laville 2004;
Evers 2005; Kendall 2009a). Social science researchers show an interest
in moving forward the study of the different partnership types estab-
lished between Third Sector organizations and the different levels of
Public Administration responsible for producing and providing services.
The coproduction (Brandsen and Pestoff 2006; Pestoff 1998; 2006),
co-management (Brandsen and van Hoult 2006) and co-governance
(Osborne 2008) concepts are the result of this interest. Research results
indicate that the different types of welfare (Defourny and Nyssen 2010)
and legislation (Zimmer 2010) in each country are the variables deter-
mining the intensity and characteristics of these partnerships. Politicians’
public agendas also play an important role. An example can be found in
the agreements signed by the UK Labour Government and the voluntary
community organizations in 1998 (Kendall 2003; 2009b).
This chapter assumes that networking and partnerships among Third
Sector organizations and the different national welfare systems explain
in part the development and consolidation of social enterprise in
Europe. The multi-stakeholder and community organization concepts
within the definition of social enterprise suggest cooperation with
key stakeholders. Cooperation means voluntary collaboration among
different stakeholders or partners continuously over some period of
time (Trigo and Drudis 1999). By analyzing strategic partnerships, the
management literature makes clear that this voluntary collaboration
is a tool for each member of a partnership organization to more easily
implement its own strategy.

170
Governance of Social Enterprises 171

The main objective of this chapter is to analyze the changing govern-


ance relationships between public authorities and social enterprises in
public service delivery. It focuses on two forms of cooperation at the
service level: first, ongoing, structured and formal dialogue between
one or several social enterprises and Third Sector organizations with
one or several public administrations, even business corporations and,
second, creation of new horizontally governed structures by different
stakeholders.
Each of these two options reflects different levels of compromise
among the stakeholders. The partnership and its degree of formalization
are more intense when the separate organizations’ goals convergence
closely and when the complementarity of their resources level is sub-
stantial. This collaboration is more fully expressed when a new organi-
zation is created and of which stakeholders are members. Nevertheless,
it is not always necessary to consider creating a new organization with
which to collaborate. The agreements and ongoing and formalized
dialogue are also important signs of collaborative interest.
The methodology used in this chapter is a combination of secondary
and primary sources, including a review of the literature and case studies
of cooperation operating in Catalonia (Spain). The emergence of social
enterprise is a result of two complementary dynamics: (i) the business
development of non-profit organizations, voluntary organizations or
civil society organizations (hereinafter all referred to as NPOs) and (ii) the
introduction of cooperatives in the social services sector in some coun-
tries characterized by a strong public administration decentralization.
In the EMES’s1 definition (2011), social enterprises are organizations
that develop a business activity to fulfill a social goal, and the main
stakeholders are represented in their governance. This multi-stakeholder
dialogue or governance characteristic supports the thesis that the social
enterprise is an organization resulting from the cooperation between
different stakeholders.
Ultimately, however, this collaboration happens because the expected
benefits for each of the stakeholders exceed the cost of participation.

National welfare systems evolution and social enterprise


development

It is assumed in this section that in European countries with a decentral-


ized welfare system, the development of the social enterprise model can
be justified by the impact that NPOs and cooperatives have experienced
as a consequence of closely collaborating with the public administration
172 Organizational Innovation in Public Services

and its associated model of management. Of the two subsections that


follow, the first is related to the changes in public demand for social serv-
ices, together with the business development of NPOs, and the second
reflects the introduction of cooperatives – especially labor and consumer
types – in the social services field after the 1980s in countries with strong
cooperative backgrounds, such as Italy and Spain.

Collaboration between public administration and non-profit


organizations
Throughout modern history, NPOs have had roles in redistribution but
nowadays some of these entities complement this role with production
of services. In the last quarter of the twentieth century, NPOs became
progressively and increasingly oriented to the market and have become
part of the value chain of the government. Chevalier (1987) describes
the 1980s as a public service explosion. The state outsources a sig-
nificant part of production and provision of social services. The public
market’s expansion entailed increasing numbers and sizes of NPOs and
also promoted creation of a business model where redistribution efforts
coexist with selling services to the state.
Implementing this business model, according DiMaggio and Powell
(1983), increases the risk that non-profit entities develop different types
of isomorphism – coercive, mimetic and regulatory – in their relation-
ship with the state. This may be problematic because Pestoff (1998)
points out that although social services are part of the services sector,
they have very specific personal features closely related to the recipient’s
idiosyncratic characteristics. Laville (2001) referred to them as proxim-
ity services, and their quality is determined by the type of relationship
between the producer and the customer, between the worker and the
client.
For example, public transportation services and public social services
are both public services but with very different characteristics. When
buying a train ticket, the service relationship between the buyer and
the provider is standardized for efficiency; whereas in social services,
the service relationship has to be customized to the needs of the recipi-
ent if it is to be efficient in terms of achieving the desired outcomes
and policy objectives. It is generally believed that NPOs can provide
services that take account of the recipient’s idiosyncratic characteristics
more effectively than can the public administration’s more standardized
support service.
It is a cause for concern, therefore, that Lewis (2004) emphasized the
NPOs’ loss of autonomy and independence, this being related to public
Governance of Social Enterprises 173

authorities deciding the amount and type of services to provide and


their funding. Nevertheless, this financial cooperation based mostly on
the client-provider relationship is also considered the seed that trans-
forms some NPOs into social enterprises.
Phases of growth of public spending are followed by recurring budget
cuts as a result of recurrent deficits and obligations arising from fiscal
policy agreements between European Union (EU) member countries. The
business management techniques incorporated by the public administra-
tion sector are the result of tension between the demand for more public
services and the need for more control of the growth of public spending.
As part of the New Public Management (NPM), by demanding better
organizational performance, the State transfers the public spending con-
trol requirement to its collaborating partners. As a result, NPOs integrate
management techniques borrowed from conventional businesses.

Box 10.1 Transformation of a quango into a social


enterprise example: Red Cross Catalonia

Before Spain joined the EU, Red Cross Spain was a quango. It had
a monopoly for public services such as ambulance transport. Once
Spain joined the EU deregulation and competitive market require-
ments became applicable in all sectors of activity. The Red Cross had
to change its business model: it went from a monopoly to a voluntary
organization providing services in increasingly competitive markets.
Red Cross Spain is a federation of autonomous organizations with
a special legal status based on NPOs formed by volunteers. During
the past 30 years, some of these organizations, such as Red Cross
Catalonia, developed a strong business capacity mainly aimed at the
public sector. Its sources of revenue in 2011 are an indicator of change
in the business model: 44.2% from selling services to the State, 29.7%
from governmental grants and donations, 16.65% from member-
ships, 4.9% from lottery; 4.6% from other income.
For further information, see www.creuroja.org last visited on
December 19, 2012.

The cooperatives’ incorporation to the national welfare system’s


value chain
Of the two roles assigned to Third Sector organizations, the production
function dominates over the distribution function in Italy (Zamagni
2012), this also being the case in Spain. This scenario allows Zamagni to
174 Organizational Innovation in Public Services

justify the social and solidary cooperatives’ presence with official recog-
nition since 1991. In Spain, however, NPOs started to collaborate in con-
struction of the welfare system in the early 1980s, since when the state
outsourced many activities related to providing and producing social
services. Public procurement facilitated creation of a vibrant public serv-
ice industry, which attracted new private organizations, such as coopera-
tives whose gradual incorporation into the spectrum of social services is
recognized institutionally by incorporating them into the Spanish law of
cooperatives. Their members voluntarily adopt the NPO model.

Box 10.2 Suara Cooperative

Suara cooperative was born in 2008 as the result of a merger between


three cooperatives with a track record of 30 years in social services
management. Suara is a workers’ cooperative providing a wide range
of social services, from daycare for children under the age of 3 years to
nursing homes for the elderly. Different branches of the Catalan public
administration responsible for social services are their main clients. In
2011, Suara administered 175 public social services, serving 25,323 cli-
ents. It had a workforce of 1,742 workers, of which 798 were members.
Their billing was 47,600,000 euros. To achieve this revenue level of
funding, Suara is constantly networking and creating partnerships with
different stakeholders. Suara believes that the collaboration between
the Public Administration and private entities takes place when they
find opportunities to collaborate and agree to cooperate in common
interest projects for the community in a win-win arrangement. Some
Suara programs of collaboration include: (1) Funding, building and
management of public facilities – joint action with a bank, a building
company and the Public Administration, (2) A project for children –
a joint action with another NPOs, a work integration social enterprise
and local public administrations. For Suara, the networking advantages
are innovation and knowledge, expansion, increased efficiency, flex-
ibility, reaching more users and greater client satisfaction.
Source: Camps 2012.

Definition of social enterprise

Scholars began to talk about social enterprise as some NPOs became pro-
gressively market oriented and growth of social cooperatives occurred in
some European countries. As Defourny and Nyssen (2010, 239) pointed
Governance of Social Enterprises 175

out, over time EMES built a social enterprise definition based on indica-
tors that ‘they describe an “ideal-type” in Weber’s terms’.
The first EMES social enterprise definition was published by Defourny
(2001), and it remained in use during the following decade. The main
change occurred when EMES members decided to divide the indicators
into three, instead of the previous two, categories. Using three cat-
egories strengthens visibility of the organization’s governance, which
EMES considers vital to distinguish a social enterprise from other agents
producing and providing social services.
EMES (2011) argues that three criteria show the business dimension
in social enterprises:

1. Continuous economic activity selling goods/services. Social enter-


prises are engaged in the continuous production of goods/services as
their main reason for existence.
2. Significant risk level. The social enterprise funding members accept
the risk totally or partially. Their financial and economic sustainabil-
ity depends on the efforts made by its promoters, members, manag-
ers and employees.
3. A minimum of paid work. The social enterprise, as well as the
NPO, combines financial and non-monetary resources, volunteers
and workers. However, the activity developed by social enterprise
requires a minimum number of paid workers. When only volunteers
run an organization, it is not considered a social enterprise.

Three other indicators reflect the social dimension:

1. A clear purpose to benefit the community. One of the social


enterprise’s main goals is to serve the community or a specific group
of people. This means, one of the social enterprise characteristics is
the wish to promote a sense of social responsibility at a local level
(Becchetti and Borzaga 2010).
2. It is an initiative taken by a group of citizens. A social enterprise
occurs as the result of a citizens’ group initiative, belonging to a com-
munity or a group sharing unmet social demands; thus they decide to
unite efforts and become entrepreneurs to promote a social enterprise.
These business initiatives are born from an organized civil society.
3. Limited benefit distribution. A social enterprise includes organiza-
tions that by law cannot distribute profit or can do so only within
strict parameters. Thus, the goal is not one of maximizing profits to
be distributed with private criteria.
176 Organizational Innovation in Public Services

The social enterprise’s corporate governance characteristics are reflected


in three additional criteria:

1. A high degree of independence. A social enterprise is voluntarily


created by a group of people governing it. It is not an organization
promoted or managed by a third party, such as the public administra-
tion, corporate foundations, corporations, unions or business federa-
tions. A social enterprise can receive grants and donations, but its
governance is in the hands of a group of people with exclusive com-
petence to make strategic decisions, including terminating the enter-
prise. (This indicator could be related to exit and voice [Hirschman
1970]).
2. Political power is not necessarily based on capital ownership.
The right to voice and to vote in the organization’s decision-making
bodies, Board and Assembly, is not necessarily proportional to the
capital provided to the enterprise. In the case of cooperatives, this
means ‘one member, one vote’.
3. Democratic governance and participation. Stakeholders are
involved actively with voice and vote in the organization’s govern-
ance. The multi-stakeholders concept includes all groups of inter-
est, such as service recipients, providers, public administration and
employees.

For EMES’s members, a social enterprise entails an organization with a


clear social goal to benefit the community. To be able to follow their
action plan more easily the organizations progressively increase their
market presence, and in some cases, they choose a multi-stakeholder
governance management model.
Entrepreneurship and the multi-stakeholder governance model should
be considered as tools available to the organization to better achieve its
action plans. As noted earlier, this model can take two different forms:
multi-stakeholder dialogue and multi-stakeholder governance. Both
mean networking among different stakeholders.
The term ‘stakeholder’ refers to groups or individuals that influence
or have been influenced by the organization’s activity. The term ‘multi-
stakeholder’ refers to different interest groups, each one of which has
different aspirations and hopes related to what it can expect from the
organization’s activity. Relationships can be formalized by a contract,
and the partners’ representation can be acknowledged through voice
and vote in governing bodies. This is referred to as a multi-stakeholder
governance model. Relationships can be structured and organized but
Governance of Social Enterprises 177

without a vote in decision-making of governing bodies: in this case, it


is preferable to have dialogue with the stakeholders.
Any organization communicates with all, or at least with some, of its
stakeholders. Communication mechanisms are varied, and the effective-
ness of the communication is also unequal depending on the stakeholder.
That said, communication is one thing and dialogue is quite another.
Dialogue suggests, as a minimum, interaction between two parties. The
concept of a multi-stakeholder organization demands a rethinking of
dialogue. There are three possible scenarios:

1. The organization conducts a multitude of independent dialogues


with its stakeholders on an individual basis.
2. A multitude of dialogues is conducted, but only some of them are
related.
3. The dialogue involves a large number of interactions among differ-
ent stakeholders regarding different topics, and this is when multi-
stakeholder dialogue takes place.

Multi-stakeholder governance is in place when this multi-stakeholder


dialogue is materialized via commitments to be met by the organization
as a result of being approved by the different stakeholders in the admin-
istration. Multi-stakeholder dialogue and multi-stakeholder governance
are instigated with the aim of improving or making more effective
action plans for each of the stakeholders involved in the alliance.

Governance of a social enterprise

EMES (2011) demonstrates that the stakeholders’ map of a social enter-


prise is large: management, employees, clients, users and providers.
However, in this section, the multi-stakeholder dialogue and govern-
ance is limited to two stakeholders: the public administration and social
enterprises.
Community service is the main characteristic of a social enterprise,
and so it may be thought that there is no discrepancy between the
public administration’s goals as client and the social enterprise’s goals
as producer and provider. This convergence of goals facilitates col-
laboration, and so both the public administration and the social enter-
prise can achieve their own action plans more easily. Accordingly, the
most appropriate corporate governance arrangements are: (a) political
power is not necessarily related to the company’s ownership; (b) demo-
cratic governance, one member-one vote; and (c) all stakeholders are
178 Organizational Innovation in Public Services

actively involved through voice and vote in governance of the social


enterprise.
Thus the public administration should be on the board of directors
of the social enterprise, and this would reduce inefficiencies gener-
ated by asymmetric information among the different stakeholders. It
is for these pragmatic reasons that EMES (2011) proposes with a board
of directors formed by members representing interests that may be
complementary.
In theoretical terms, however, it may not always be appropriate for
the public administration to be on the board of directors, most notably
where the key assumption is separation of ownership from management
functions. Although a theory specifically about the functions of corpo-
rate governance and management in a social enterprise still remains
to be developed, we can utilize theory developed for the for-profit
company, there being two main models: Agency theory (Jensen and
Meckling 1976) and Stewardship theory (Muth and Donaldson 1998).
‘Agency theory’ is most often used to explain the business and
corporate governance arrangements. There is an agency relationship
whenever one party depends on action to be taken by another party.
The one who takes action is called the ‘agent’. The one who is affected
by the Agent’s action is called the ‘principal’. Hence, agency theory is
also known as the principal-agent theory. The existence of informa-
tion asymmetries is a central element of their relationship, as is the dis-
crepancy between the agent’s and the principal’s goals. Agency theory
holds that public services providers have different interests to those of
the public administration. From this perspective, agency theory would
not accept a board of directors with some members representing clients
and other members representing the service provider.
‘Stewardship theory’ does allow customers and providers to be mem-
bers of the same board of directors. In the stewardship theory, the board
of directors’ main goal would be to provide information and assist the
company’s executive team to achieve excellence as the social service
provider. From this perspective, Stewardship Theory accepts the cus-
tomer and the provider working together to improve the strategy and
to add value to high-level decisions.
Cornforth (2004) added two new models for NPOs and coopera-
tives: the democratic model, one member-one vote; and the multi-
stakeholder model. The latter can be seen as an extension of the former
but Cornforth wonders how to integrate the four models mentioned.
Stewardship Theory, democracy and various stakeholders’ participa-
tion in the board of directors are models coexisting in the management
Governance of Social Enterprises 179

of social enterprise corporate governance. A well-integrated combina-


tion of these three models can help to resolve the agency problems
arising among the stakeholders. In this case, addressing principal-agent
problems becomes irrelevant.
In order to visualize the multi-stakeholder dialogue and the multi-
stakeholder governance concepts, this section is now divided in two sub-
sections. The first subsection presents the Alerts Monitoring Intelligent
System Program, managed by the Spanish Red Cross in the senior citi-
zens field, as an example of a strategic alliance created from the dialogue
amongst different stakeholders; the second subsection analyzes FASI
Foundation and its Casals d’Infants program in the social education field
as an example of a strategic alliance with a multi-stakeholder governance
between public administration and social agents.

An example of multi-stakeholder dialogue


The Spanish Red Cross is the leader in the Alerts Monitoring Intelligent
System Program (SIMAP) in the senior citizens service field. Its main
goal is to promote autonomy and mobility for cognitively impaired
people (Roig 2012).
At the beginning of the twenty-first century the Red Cross staff
detected an unmet demand: the need to offer a service providing safety
for people experiencing cognitive impairment but who want to keep
their mobility. Once the unmet demand was detected, some Red Cross
regional levels considered designing and providing services within each
of its territories.
This service demands a technological solution: a geographical loca-
tion device via GPS mobile satellite network providing automatic warn-
ings to the central monitoring station if the user has: (i) left the safe
zone (previously determined), (ii) increases the movement rate (more
than 35km per hour, for example caused by riding transportation) and
(iii) control if the battery level is low.
The Red Cross organizations providing services at a regional level do
not have the resources, technology or knowledge to provide this service
themselves. As a result, they choose to create a core partnership formed
by each of the Red Cross organizations at regional level, a GPS tech-
nology company responsible for renewing the product and a mobile
phone company providing services at special rates. From this core, each
Red Cross organization at regional level complements the partnership
with new members. For example, in Catalonia the Catalan Federated
Association of Relatives of Alzheimer Patients is also one of the partner-
ship members. The regional and local public administrations provide
180 Organizational Innovation in Public Services

the financial resources to cover the service management costs. Managed


by the Catalan Red Cross, the SIMAP program is an example of a part-
nership among various agents with supplemental resources.

An example of multi-stakeholder governance in social education


The Educational Platform Foundation was created in 1994 as a result of
a voluntary association of 10 social entities in the social education field.
The beneficiaries are children and adolescents at risk in Catalonia. The
main reason for the partnership is the complementarity among mem-
bers, allowing each member to take advantage of economies of scale;
which in turn can offer a bigger pool of specialized staff to the client,
the public administration. In 2011, the partnership members had 19.5
million euros in revenue, of which 60.18 per cent were for services pro-
vided, 17.04 per cent from public grants, 12.67 per cent from donations
and only 0.47 per cent from user fees. Ultimately, its main preferred
client is the public administration (Fundación Plataforma Educativa
2012). In this example, the client and beneficiary are not the same.
In the Educational Platform Foundation business model vision, inno-
vation is essential to increase quality and efficiency in services and pro-
moting sustainability of the organization’s members. Nevertheless, the
Catalan Regional Government, Generalitat de Catalunya, has exclusive
competence for child protection and assistance to families and children.
However, legislation (D.O.G.C. 2010) enables the Educational Platform
Foundation to design a project engaging institutions to respond better
and differently to children and adolescents who are at risk.
Its design and construction of the partnership was presented to
Generalitat de Catalunya’s decision-makers in the Child and Adolescent
unit of the Social Action and Citizenship Department, and the Social
Action and Citizenship Department accepted being the leader in this
partnership between the public sector, social enterprise, Educational
Platform and the private business sector incorporated within the group
as a potential investor. This partnership became the Childhood Social
Action Public Foundation (FASI), creating a new structure horizontally
governed by three big participants:

• The public sector, represented by the Social Action Consortium of


Catalonia – public agency under the Catalan Generalitat govern-
ment’s Department of Family and Welfare – with four members on
the board of directors.
• The social enterprise, represented by the Educational Platform with
two members on the board of directors.
Governance of Social Enterprises 181

• A building company, whose main shareholder is a mutual benefit


society. The building company has one member on the Foundation
Board of Directors.

The Casa d’Infants program must allow the Catalan Generalitat to meet
its institutional obligation to minors in Barcelona city. While ensuring
both quality and efficiency of service, the basic goal is the creation of
200 residential slots to accommodate children and adolescents at risk
with their families currently receiving formal support from the Catalan
Generalitat government’s Department of Family and Welfare.
Both the SIMAP and Casa d’Infants programs are well-established
examples of voluntary collaboration between different organizations.
However, the cooperation between the various agents is different. In
the SIMAP program, it is a continuous, structured and formal dialogue
led and managed by the Red Cross’ Catalonia together with the public
administration, different mobile phone companies and other NPOs aim-
ing to provide a new social service. In the Casa d’Infants program, the
cooperation between the public administration, NPO and the for-profit
company was formalized with the creation of a new legal structure, FASI
Foundation, in which the three stakeholders are represented on the
Board of Directors. The decision-making process is based on the one-
member–one-vote mechanism. However, the public administration has
four members, the NPO has two and the for-profit has one. The public
administration holds the presidency. The mission of the FASI Foundation
board of directors is to provide a better and different organizational
response to provide public services for children and adolescents at risk.
The duty of the FASI Foundation’s board of director members (rep-
resenting the stakeholders for and non-for-profit organizations) is to
collaborate with the public administration providing equipment, infor-
mation, knowledge and experience. The stakeholders’ collaboration
through the ‘one member, one vote’ mechanism suggests that the FASI
governance management style is characterized by a combination of the
models outlined earlier: stewardship, democracy and multi-stakeholder
participation.

Conclusions

This chapter contends that networking and partnership relationships


between Third Sector organizations and the different national welfare
systems explain, in part, the development and consolidation of social
enterprises in Europe. As defined by EMES (2011), the participatory
182 Organizational Innovation in Public Services

and democratic governance characteristics of social enterprises indi-


cates work in cooperation with stakeholders. Careful combination of
Stewardship theory, democracy, multi-stakeholder dialogue or multi-
stakeholder governance models can help solve the agency problems
arising between stakeholders.
To help visualize this solution, this chapter has used two illustrative
short case studies of cooperation based on two different levels of com-
mitment between organizations. The SIMAP program is an example
of multi-stakeholder dialogue enabling the provision of a new service
aimed at promoting autonomy among people with a certain level of
cognitive impairment. The FASI Foundation was created to formalize
the strategic alliance between the public administration, for-profit and
not-for-profit organizations to improve the quality of services for chil-
dren and adolescents at risk of social exclusion.
For Bacchiega and Borzaga (2001), the existence of multi-stakeholder
dialogue and multi-stakeholder governance is the result of a construc-
tion and accumulation process of mutual trust between the different
stakeholders that are part of the strategic alliance. Multi-stakeholder
dialogue and multi-stakeholder governance management should aim
at meeting its members’ expectations. The fulfillment of this objective
requires managers to measure and evaluate the program or the new
organization’s performance in terms of its stakeholders’ expectations.
This measurement and evaluation exercise is also a tool that should
be used to negotiate and reach agreements to prioritize expectations
among different stakeholders. Ultimately, accountability is a tool to
facilitate the management of a dialogue between the different stake-
holders, or among members of the social enterprise’s decision-making
bodies. The multi-stakeholder dialogue or governance needs to incorpo-
rate governance models promoting transparency, control and horizontal
co-governance in the organization. The presence of the public adminis-
tration in the organization’s political bodies also requires an increased
focus on this partner’s interests. However, multi-stakeholder governance
of a social enterprise providing public service does not necessarily mean
a direct and physical presence of the public administration in the social
enterprise’s political bodies.
Multi-stakeholder dialogue and multi-stakeholder governance are two
concepts gaining popularity. Andrews et al. (2006) think that a partner-
ship between the local public administration and NPOs, especially with
the private sector, is a way to increase their quality providing services.
Researchers also began to produce literature from the social enterprise’s
point of view. The Italian Impresa Sociale journal review (2008) was
Governance of Social Enterprises 183

a first example; it had a special issue devoted to progress in the theoreti-


cal study of the multi-stakeholder governance on social enterprise.
However, the multi-stakeholder dialogue and multi-stakeholder gov-
ernance concepts are not without risks. Andrews et al. (2006) recognize
that the local government involvement in the voluntary organizations’
governance providing social services generate new costs for the public
administration.
For a private organization, having public administration representa-
tives in its political decision bodies also has a cost in terms of reduced or
constrained autonomy. If, despite the existence of costs, different stake-
holders continue using the dialogue or the multi-stakeholder organiza-
tion’s governance as an expression of coordination, it is because there are
three circumstances closely related to the reason for this cooperation:

1. Uncertainty: Asymmetric or incomplete information and, as a result,


the increased likelihood of making inefficient decisions.
2. Strategic interdependence: One side’s results (benefits) depend on
the other side’s decision-making.
3. Possibilities for improvement: Caused by networking and which
are significant for each of the networked stakeholders.

Coordination is not needed if there is no uncertainty or interdepend-


ence. For that reason, coordination is appropriate when those circum-
stances are present. The public administration and the social enterprise
want to share a multi-stakeholder dialogue with other stakeholders
because it is convenient, adds value and helps them achieve their own
goals. A NPO accepts sharing multi-stakeholder dialogue or governance
with the public administration because it believes it is the most efficient
way to develop its business strategy.
The social enterprise is already a form of systematic cooperation by
means of which the interests of the different stakeholder groups can
be promoted. However, synergies and complementarities are necessary
but not sufficient for the development of cooperation between differ-
ent stakeholders. The cooperation value obtained from the partnership
needs to exceed the costs of the partnership; and in addition, each
participant must obtain at least the same result that could be achieved
with their best alternative arrangement available outside the partner-
ship (in other words, their opportunity cost). Here, the opportunity cost
or alternative cost refers to what each of the cooperative’s members is
deprived of or renounces when it chooses to be part of a dialogue or a
multi-stakeholder governance.
184 Organizational Innovation in Public Services

Due to space reasons, this chapter has focused on the multi-stakeholder


model of one social enterprise profile: an organization whose primary
income source comes from the public administration. This profile corre-
sponds to the dominant social enterprise in Europe. The national welfare
system’s development can become a transformation engine for non-
profit entities to become social enterprises, and the cooperative model’s
entry into the social service industry is considered a valid assumption for
countries with generous public welfare systems.
However, this assumption is not valid in those countries where there is
a deeply rooted tradition of subsidiarity and responsibility of the citizen
in promoting community welfare, in the USA for example. Nevertheless,
similar to European NPOs and cooperatives, some NPOs in the USA have
gradually complemented their redistribution activities with production
activities; and at the same time, new private organizations with social
purposes have come onto the scene. In this evolution, unlike Europe,
the relationships between government and NPOs do not explain this
process. The NPOs’ main stakeholder is the philanthropic and volunteer-
ism tradition that American society has developed during its history. As
noted by Young (2012), the new forms of multi-stakeholder dialogue and
multi-stakeholder governance forged over time between NPOs and busi-
ness corporations in the USA are one of the reasons for this evolution.
The result is the evolution of NPOs into hybrid organizations combining
redistribution and production functions oriented to the private market.
Ultimately, the various institutional settings explain the differing
expressions of social enterprises in different countries. Without stand-
ard legal forms and statistical databases for different countries, it is
very difficult to collect information to assess the impact of multi-stake-
holder model as a tool to better meet the expectations of the various
stakeholders that voluntarily agree to be part of the governance bod-
ies. It is important to emphasize that both voluntary and community
organizations in the UK (Taylor 2004; 2012) and the social managers
of the initiatives analyzed in this chapter Suara (Camps 2012), Red
Cross (Roig, 2012) and Educational Platform Foundation (Fundación
Plataforma Educativa, 2012) are in favor of this new form of governance
and believe that there is no going back.

Note
1. EMES is the acronym for l’Emergence de l’Enterprise Social. It is a network of
European research centers and researchers. Individual and collective books and
articles are published about the social enterprise concept. Access to an important
library of working papers about social enterprises in different social work fields
in Europe can be obtained through a visit to their Web site www.emes.net.
Governance of Social Enterprises 185

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11
Championing and Governing UK
Public Service Mutuals
Jane Tinkler and Paul Rainford

Introduction

For the UK Conservative-Liberal Democrat coalition government,


elected in 2010, reform of the public sector was hailed as a priority in
order to maintain quality and coverage of services at a time of austerity
and huge cuts to government budgets. The coalition sought to encour-
age the spinning out of services to new employee-owned mutuals that
are able to innovate, reduce costs and improve conditions for both
employees and service users. This was linked to a wider drive to harness
the energy and creativity of local communities and voluntary groups by
better integrating them with the production and delivery of services.
This chapter looks at how the expansion of mutuals in the public sec-
tor links to the Big Society initiative, particularly the open public serv-
ices agenda and examines the challenges and opportunities for public
innovation and governance in a new era of open public services. How
new mutual providers are created and controlled will be vital to maxi-
mizing their innovative potential as well as the quality of the services
they provide.

Definition and form

A mutual organization is one in which the users and/or employees are


members and they control its provision of services (Birchall 2004). Mutuals
are established ‘to serve a specific community or interest group’, ‘profits
are usually reinvested in the mutual for the benefit of the members’ and
the governance structures ‘formally incorporate stakeholder interests
with different stakeholders having an appropriate role in running the
organisation proportional to their relevant stake’ (TUC 2010, 3).
187
188 Organizational Innovation in Public Services

The mutual sector in the UK has undergone somewhat of a resurgence


in recent years, with revenues growing from £84 billion, in 2008, to
£112 billion, in 2011 (Groom 2012). In addition, there is a long history
of mutuals being actively involved in public sector service provision,
with support coming, to varying degrees, from both sides of the politi-
cal spectrum (Blond 2010; Innovation Unit 2009; Labour Party 2002;
Mayo and Moore 2001). There is also a renewed interest within the
private sector in models of co-operation (Murray 2012, 1). This stems
from the recognition that innovation, rather than price, is now key to
economic growth, while the Web has enabled large-scale formal and
informal cooperation via networks.

Public service mutualization in the big society

From the outset, the Big Society was, and still remains, a nebulous con-
cept. Exact policy implications have been underdeveloped, and the idea
has undergone several, relatively unsuccessful, reinterpretations. Francis
Maude, the minister in charge of this agenda, has admitted that ‘the
big society is a big idea, not a big plan’ (quoted in Wilding 2010). Three
broad initiatives are generally associated with the policy: increased local-
ism and community empowerment; greater government openness and
transparency; and opening up public service delivery to new local pro-
viders. There is inextricable interweaving between these three themes,
and it is largely the open public-service agenda that has come to domi-
nate through the creation of new mutual service providers. We look at
each in turn but focus mainly on the open public-service aspects.

Increased localism and community empowerment


The government’s vision is to change ‘the way services are delivered
by redistributing power away from central government’ (HM Treasury
2010a, 8). The most obvious beneficiaries of this change will be England’s
353 local authorities. These bodies already have a general power of com-
petence that will be enhanced by the Localism Act 2011, while some
budgetary restrictions will be loosened. However, the Act does not devolve
further tax raising or income generating powers to local government
which, critics claim, will stifle their ability to make the most of the reform
(Travers 2011). The Act entails both a reorganization of how central gov-
ernment sees service provision and how local government implements it.
As such, ‘the Big Society and the reform of local governance . . . are intrin-
sically linked’ (Lowndes and Pratchett 2011, 31). There is also a focus on
encouraging the wider public, voluntary groups and the third sector to
become more involved in the day-to-day running of services. The 2011 Act
Championing & Governing UK Public Service Mutuals 189

gives greater powers to communities including more control over housing


and planning decisions, while the Community Right to Challenge enables
civil society groups to bid to run local authority services.

Greater government openness and transparency


An overarching UK government priority is to be the most open and
transparent government in the world. There is a growing body of litera-
ture on the potential for change from opening up public sector infor-
mation (Hartley 2005; Dunleavy et al. 2006; Windrum and Koch 2008),
and financial support has been given to the data.gov.uk platform to
host datasets for use in innovative ways. Two sets of information are
most relevant here: all spending by central government over £25,000
must be published each month, with the disclosure limit in local gov-
ernment being £500; and full breakdowns of tenders and commission-
ing decisions must be published. The hope is to encourage ‘armchair
auditors’ who will provide community oversight of council spending
and commissioning decisions, thereby increasing public involvement
and buy-in of service priorities. Data may also provide ammunition for
service users on failing and costly services, encouraging them to see
where they could potentially provide a better service.

Opening up public services


The open public services agenda seeks to promote the growth of alterna-
tive delivery providers. This includes mutuals, private sector companies
and social enterprises, but the debate on the types of organization that
are envisaged lacks a degree of nuance. There is little understanding of
how the legal status of alternative delivery providers can affect what
they are able to provide, how they are governed or how they relate to
their users. Examining the strengths and weaknesses of each provider
‘type’ is therefore difficult and made more so by the overlap of defini-
tions of social enterprises, cooperatives, mutuals, employee-owned and
so on. The term that is most used in public discourse is social enterprise,
encompassing organizations that have social rather than profit maxi-
mizing objectives. However social enterprises can be fairly conventional
for-profit companies.
The 2010 Comprehensive Spending Review provided for ‘a right for
public sector workers to form employee-owned cooperatives and mutu-
als to take over the services they deliver’ (HM Treasury 2010a, 35).
Francis Maude outlined his goal (Williams 2011):

There are 6 million people who work in the public sector at the
moment. It would be very ambitious, but is not inconceivable, that
190 Organizational Innovation in Public Services

at the end of the Parliament, 2015, you might have as many as


1 million workers who would be co-owners in some form of the pub-
lic service entity that they’re part of.

Maude (2010) explicitly linked this goal with making the public sector
more innovative: ‘The creation and growth of public service mutuals are
at the heart of the drive to replace top-down monopolies with open net-
works of diverse and innovative providers’ (Mutuals Taskforce 2012, 5).
The Right to Request Programme was originally instigated under the
previous Labour government, but its inclusion in the 2011 white paper
on Open Public Services highlighted the coalition’s commitment to this
policy (HM Government 2010; 2011; 2012). A Mutuals Information
Service was created in the Cabinet Office to provide help and support for
employees and others that were considering this option and a Mutuals
Taskforce, involving prominent mutual representatives and academics,
was convened in 2011 to provide an evidence base along with recom-
mendations and challenges to government policy. As a result, there are
‘around 20,000 public servants now working in new public sector mutu-
als with contracts worth about £1 billion. By the end of 2011, 40 new
mutuals had formed by spinning out from NHS and Primary Care Trusts’
(Mutuals Taskforce 2012).
The Mutuals Taskforce highlighted evidence to show that mutuals
provide benefits both for employees and service users, whose knowledge
has previously been woefully underused by public sector organizations –
especially in relation to making innovative changes (NAO 2005).
Employee ownership can provide staff with financial and emotional
incentives that make them more committed to their organization and
therefore more motivated (Mutuals Taskforce 2012). This can in turn
lead to increased staff productivity and decreased absenteeism and sick-
ness rates (Ellins and Ham 2009). As mutuals are accountable to their
users, rather than to shareholders, evidence has also shown a higher
level of customer trust and loyalty (Ellins and Ham 2009).
It is quite feasible that, by opening up public service delivery to new
ideas and energies, the government will be able to reduce costs, diver-
sify and share risks, prevent duplication and encourage collaboration
with (and thereby learn from) the wider business and voluntary sectors
who are engaged in fields of shared interest. Coproduction with smaller
and more flexible provider types would allow for particular user groups
to receive localized and targeted services. By encouraging a ‘customer
focused radical disintermediation’ in public services – that is the strip-
ping out of intermediaries in the delivery chain and the simplification
Championing & Governing UK Public Service Mutuals 191

of the institutional landscape – and by seeking to curtail top-down


imposed changes, there could be greater needs-based provision that is
able to adapt to problems in real time.
Public service mutualization will work best where the original moti-
vation and support for change is allowed to develop organically. The
All-Party Parliamentary Group on employee ownership has already
expressed concern that ‘some spin outs appear to be solely driven from
very senior level, typically under the pressure of the need for immedi-
ate short term cuts, with the wider base of employees engaged after the
process has started’ (APPGEO 2011, 16) Research conducted by the Civil
Service Live Network found 69 per cent of civil servants to be against
spinning out their service to be run as a mutual. Survey results showed
that the attractions for civil servants, both those for and against mutu-
alization, were the ‘opportunity to focus on public benefit rather than
institutional interests’ and ‘greater operational freedom’. However, by
arguing against an asset lock that would guarantee in perpetuity new
mutuals’ charitable status or employee ownership, Francis Maude has
focused on employee entrepreneurialism, which sees rewards largely in
financial terms.

The government has misdiagnosed both what attracts civil serv-


ants to the idea and what scares them about it, and thus has built a
policy that arouses the suspicions of sceptics while missing chances
to entice the interested . . . Maude will win more support if he
emphasises mutuals’ ability to achieve public aims more effectively,
not their potential to privatise the rewards of success’. (Civil Service
Live Network 2012)

In addition, professional groups are powerful and vocal on proposals


that seem to reduce their influence or control on decisions or funding.
Birchall (2004, 90) argues that mutualism:

goes against many bureau-professionals’ deeply-held belief in the


value of “technical competence” and threatens the interests of those
who find a paternalistic relationship with “their” service users psy-
chologically rewarding.

Some believe that the support of mutuals is in part recognition that


public opinion is more supportive of social enterprises in general than pri-
vate sector providers: ‘Councils . . . are increasingly viewing social enter-
prise as a positive alternative to out and out privatisation, particularly
192 Organizational Innovation in Public Services

in services where profit-maximising operators might not go down well


with voters’ (Deardon-Philips 2012). The value for some mutuals being
created from pre-existing local groups is that their support already exists.
For other mutuals, this public support will need to be built and therefore
public opinion about mutualization itself will be important. Replacing
highly regarded or long-standing services seen as ‘public’ with a mutual-
ized service that may look very different, regardless of its quality, may
be a tough sell.
These new provider options are not neat substitutes for government
and cannot be expected to fill the breach if funding and central sup-
port is absent or insufficient. There are real capacity-building issues that
must be addressed as austerity measures threaten to strip out any capa-
bility local authorities and civil society may have to support the mutual
agenda – not only in terms of direct funding but also indirectly in the
provision of skilled input from lawyers, research organizations, public
policy experts and so on. Mutualization should not be seen as a way to
cheaply devolve services that the government or local authorities con-
sider to be no longer affordable (Tinkler and Rainford 2010).

Creation and support of public service mutuals

The UK government does not have a particularly good track record in


handling sets of new providers and creating a market in which they are
able to compete. Government has traditionally contracted with large pri-
vate sector organizations, and the pressure on developing an open public
services market will be to ensure that organizations providing smaller
scale services for particular groups are able to compete against those that
are able to leverage scale in order to win contracts. The public sector IT
market, for example, has long been dominated by a few large companies
holding up to 80 per cent of market share (PASC 2011a; NAO 2011).
Mutuals will need a high level of support in order to overcome bar-
riers to their entry into the market. A key point in the development of
a new mutual provider will be the decision on when and how to scale
up a service if it becomes successful. As their scope widens, there will
be an inevitable process of professionalization and a requirement for
the input of capital. The public sector employee-led mutuals that have
been set up since 2010 have mostly been developed through the Mutual
Pathfinder project led by the Mutuals Team in the Cabinet Office. Two
key questions will be how the government will help to ensure that new
groups can be created outside of this support structure and how it will
control them once they are functioning.
Championing & Governing UK Public Service Mutuals 193

At the most basic level, government’s role is to provide information


and support to all those that wish to engage with or provide services.
Mutuals and their advocacy groups say that an important factor in grow-
ing the mutualization agenda is the provision of the necessary support
for the difficult transition from public ownership to mutual status. The
Mutuals Support Fund has been set at only £10 million over three years
and a recent All-Party Parliamentary Group on mutuals heard evidence
detailing the ‘lack of access to genuinely expert support and advice, and
a budget to cover the cost of that advice’ (APPGEO 2011, 12). A report
by the Institute for Government called for an ‘accountability map’ to be
developed for each publicly funded market setting out the divisions of
responsibility and clarifying the role of regulators, providers and service
users (Blatchford and Gash 2012). In particular, Transfer of Undertakings
Protection of Employment (TUPE) and pension liabilities pose signifi-
cant complexities that will have to be carefully managed, otherwise this
threatens to make mutuals uncompetitive from their inception.
Engagement with external service providers has previously been
achieved using a variety of platforms and delivery methods, from pri-
vatization to outsourcing and partnerships. New Public Management
(NPM) ideas encouraged professionalization of the commissioning proc-
ess as a way of ensuring that cost effectiveness and minimum quality
standards increased over time. However, there is a lack of skilled com-
missioners within government, especially those who are able to see their
role in a more flexible way (Erridge and Greer 2000; Singh 2010; Rees
et al. 2012).
Past experience in the UK shows that employee-owned organizations
have not been able to compete in the open market. Of the landlords
that took over former local authority housing stock, over half have now
re-agglomerated into larger and generally less locally based group struc-
tures (Pawson and Mullins 2010). In the transport sector, there were a
number of employee buyouts of London and regional services as part
of the deregulation of the bus industry. None of these employee-owned
companies still exist because the deregulated market forced smaller oper-
ators to consolidate and merge to achieve essential economies of scale
(APPGEO 2011). This route has been shown to improve productivity
but it naturally ‘weakens the ties of membership’ that are part of the
reason that the mutual thrived in the first place (Murray 2012, 3).
Alternatively, mutuals have collaborated and created specialized or com-
plementary consortia for operations where scale is significant or where it
means being able to offer a wider range of services than possible alone
(i.e., economies of scope).
194 Organizational Innovation in Public Services

Government must balance the flexibility of the mutual model, and


the innovation that this may facilitate, with the economies of scale and
comprehensive coverage of service that larger providers can bring. The
challenge will be to create a flexible and agile procurement process from
a current system that is bureaucratic and inflexible. Indeed, the public
sector commissioning process is widely seen as the most significant bar-
rier to opening up service delivery to big society type providers (Singh
2010; PASC 2011b).
There is a large literature on the high transaction costs for third sec-
tor organizations in bidding for work with government (NAO 2007;
Macmillan 2010; Bennett 2012). Despite some rationalization, there are
still a number of different procurement systems and requirements for
those wanting to bid for government work to understand and use. The
Cabinet Office (2010) ran a modernizing commissioning consultation
but there is not, for example, a single procurement portal to facilitate
bidding for government work. Companies expect to put in time for the
bidding process equal to approximately 5 per cent of the contract price.
With government work, this can be significantly more, and case studies
put costs at closer to 20 per cent (Singh 2010). This is especially difficult
for those organizations that do not have large corporate, administrative
or legal teams or prior knowledge of the process.
Bidding organizations are asked to provide evidence of their status and
track record in a Pre-Qualification Questionnaire. Often bodies will be
asked to provide years’ worth of bank statements to show their financial
probity and also their track record in providing similar services to other
bodies in the past. The Mutuals Taskforce recognized the difficulties
posed by these requirements and recommended using other measures of
assessing financial surety. The government has in certain circumstances
awarded an initial time-limited contract to give a new mutual time to
establish itself, develop its business capacity and grow before being subject
to a full and open competition (Mutuals Taskforce 2012, 36). This strategy
was used in the case of MyCSP, the civil service pension mutual spin-out,
which partnered with Paymaster in order to develop market functions
and plug the skills gap before an open competition takes place.
A recent development in this area is the Public Services (Social Value)
Act 2012. Commissioners will be legally obliged to ‘look at what the col-
lective benefit to a community is when a public body chooses to award a
contract . . . Value for money is the overriding factor that determines all
public sector procurement decisions. However, there is a growing under-
standing of how value for money is calculated and how “the whole life
cycle requirements” can include social and economic requirements’
Championing & Governing UK Public Service Mutuals 195

(Social Enterprise UK 2012, 6). New mutuals will simply not be able to
compete on the basis of lowest price, but commissioning for social value
could allow public bodies to focus not just on cost but on outcomes and
well-being too. Indeed, ‘the recent consolidation of EU procurement
framework also makes it clear that social requirements can be fully
embraced in procurement practice’ (Social Enterprise UK 2012, 6).
Once a contractual relationship has been created between the govern-
ment and a mutual, there are a number of levers at the government’s
disposal in order to control the relationship. But the amount of influ-
ence each party has over the continuing relationship will depend on the
strength of the procurement contract and the threat of non-renewal.
Government is not seen as adept at creating contracts that are flex-
ible enough to both provide value for money as well as be able to pick
up the slack when conditions, populations or technologies change
(Dunleavy et al. 2006). The private sector has made considerable profit
from government upgrading or adding new services to contracts during
the course of their, usually long, life. This flexibility will be difficult for
mutuals to sustain because of their size and resource limitations. It will
be for the government to ensure the continued support for mutuals by
examining how the first wave continues to develop following the end
of their initial contracts.

Quality, coverage and oversight of mutuals

The mutualization model shows distinct differences from the outsourc-


ing model favored by the previous Labour government. Despite their
commitment to involving third and private sector organizations in the
delivery of services, Labour envisaged a strong role for local and national
government actors via the creation of partnerships between delivery
and government bodies. Academic research supported this position:
‘Research on local government shows that a vibrant civil society tends
to go hand in hand with a vigorous local council: they are not alterna-
tives or competitors’ (Lowndes and Pratchett 2006, 32). A key aspect will
be how to assess and influence the quality of the services provided when
the responsibility for the provision of the service continues to rest with
government, even if the delivery does not. How will this gap between
responsibility and delivery play out?

Integrating new providers with existing public sector services


Encouraging the growth of mutuals will increase the number of providers
in the public sector market. Increased disaggregation and fragmentation
196 Organizational Innovation in Public Services

mean that small and flexible organizations have to be factored against


ones that are larger and less flexible but bring economies of scale, as
was clearly seen during the NPM era (Dunleavy et al. 2006). Scaling up
mutuals may be positive for competition and efficiency but, in doing
so, some of the characteristics that made them successful may be diluted
or lost. At a time of austerity the replication of functions across a larger
range of small providers does not fit with the disintermediation and
reintegration push that followed NPM and was encapsulated by the
Total Place initiative.
Total Place tracked expenditure flows from central government to
the localities and then correlated ‘the finance received with the tasks
being undertaken by local governments, NHS bodies, police authorities,
quasi-government agencies and central government departments and
executive agencies’ (Dunleavy 2010, 20; see also HM Treasury 2010b).
The pilot scheme found areas of overlap and duplication in service
provision that for some locations amounted to 25–35 per cent of local
costs. The Total Place initiative (now replaced by ‘Community-Based
Budgets’) focused primarily on potential cost savings by avoiding dupli-
cation within the conventional service model whereas mutualization
focuses primarily on innovative models of service provision that engage
employees, service users and bodies other than the private sector.
An increased numbers of providers could reduce government’s pur-
chasing power and its ability to negotiate lower input prices, as high-
lighted in the Green Review on government procurement (Green 2011).
In order to obtain the full benefits of new providers entering the public
sector market, some existing services should also be terminated or
downscaled and those providers who are under-performing should be
decommissioned (Bunt and Leadbeater 2012). Maximizing the innova-
tive potential of this policy agenda will be key to offsetting increased
goods and services costs.

Comparing hyper-local services to ensure quality


Services will no longer be provided in the same way across a whole local
region. Hyper-local mutuals will work with their stakeholders to deter-
mine exactly what service they will provide, how they will do so and to
what extent service users are involved. The government hopes this inno-
vative approach will enable local services to match more closely with
local needs, entailing higher productivity and lower cost. The definition
of what a well-performing or value for money service looks like will vary
depending on which organization is providing that service. A common
concern in the UK, that has traction with the media, is that of ‘postcode
Championing & Governing UK Public Service Mutuals 197

lotteries’. The government bears a responsibility for ensuring that qual-


ity and access to services should be equal for all. Differences in service or
coverage for some areas, or postcodes, can be seen in distinctly negative
terms as a failure of government provision. How will local choice be
reconciled with equality of access to services and will local authorities or
central government be in a position to make these judgments?
Those families, for example, with multiple and complex needs are
already difficult to reach by mainstream service provision as they inter-
act with a number of different departments or bodies within the public
sector. A mutualized model would continue to ask these groups to inter-
act with a number of different organizations in order to access services
and could result in significant ‘cream skimming’ with municipal serv-
ices left to deal with difficult and resource intensive cases.

Collecting information and handling audit and oversight


Despite the smaller role envisaged for central government in these
plans, it will still have to act as an ‘intelligent centre’ overseeing local-
ized delivery via detailed information collection and analysis (e.g., MIS
2012). However, details in the Localism Act 2011 on data reporting show
the information collected will also be linked to local priorities. Local
authorities and public bodies will be expected to develop their own
performance measures and reporting processes, to focus on those that
local communities feel are important rather than those that are nation-
ally prescribed (Lowndes and Pratchett 2011). Eric Pickles, the secretary
of state for Communities and Local Government, has pledged that local
authorities will have the freedom to appoint their own auditors. Critics
of this move argue that ‘the ability to choose an auditor reduces inde-
pendence and hence quality’ (Ellwood and Garcia-Lacalle 2012).
This is linked to the abolition of the Audit Commission, which ran
the comprehensive audit process for local government and set standard
reporting processes across all authorities. The role of audit and over-
sight is an important check and balance in ensuring the quality and
value for money of services. In the past, the uniform nature of provi-
sion allowed them to be compared fairly easily and under-performing
or costly local providers could be targeted for support or focus in order
to drive improvements. It will no longer be possible to compare across
like-for-like services, and therefore audit bodies will need to develop
methodologies that allow them to compare heterogeneous services.
They will have to be able to assess whether a mutual is providing a good
service in relation to what it promised its users and that it is spending its
budget in an effective way. Indeed, it will be ‘difficult, if not impossible,
198 Organizational Innovation in Public Services

for localities to be benchmarked or compared. Consequently, there will


be no high profile failures being published by government’ (Lowndes
and Pratchett 2011, 36).
The transparency agenda could be seen as a useful lever, with local
users being able to access government data to examine the performance
and efficiency of local services. However the contracts between the
government and mutuals would need to include more stringent require-
ments for data to be made publicly available. This rarely happens and
the Freedom of Information (FOI) Act 2000, which, despite applying
to all UK public sector bodies, has not been extended to cover other
organizations providing public services. The Open Public Services white
paper is ‘almost totally silent’ on FOI, and it is ‘highly unlikely’ that the
Act will be extended to cover private providers (Prosser 2011, 20).

Risk of failure
There are currently no contingencies in place for safeguarding services
if new providers fail. In the case of hyper-local mutuals, their small
scale would make this more manageable, but the collapse of trans-local
mutuals – those that have scaled up and are providing multiple services –
could pose significant problems. When commissioning services, govern-
ments have been keen to try and outsource the risk of failure to private
or other providers, although where the ultimate responsibilities of the
service remain with the government, so too does the risk.

Conclusion

The growth of public sector mutuals in the UK could prove to be a valu-


able addition to conventional models of service provision in terms of
driving competition, efficiency and innovation. They have the poten-
tial to empower employees and service users to take a more active role
in public life, utilizing front-line knowledge of what is needed and what
works, and engaging citizens in a much more meaningful way in local
provision. However, the UK government is not an intelligent customer.
It currently lacks the skills to creatively commission and nurture mutual
services, and is poor at collecting the vital information on performance
and finances to ensure that quality and value for money are being pro-
vided. Audit and oversight will need to catch up with the changes that
the mutualized landscape will bring. The success of further mutualiza-
tion will require that the public sector in general becomes less fixed
and less uniform, allowing alternative delivery providers the space to
compete and innovate. It remains to be seen how far mutualization of
Championing & Governing UK Public Service Mutuals 199

service delivery will progress, what forms it will take (in terms of the
size and scope of mutual organizations), how effectively mutuals will be
governed and how durable they will prove to be in increasingly com-
petitive public service procurement markets.

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12
Improving Governance
Arrangements for Academic
Entrepreneurship
Matthew S. Wood

Introduction

The global economic crisis has led to a number of important paradigm


shifts. One of these shifts is the growing recognition that entrepreneur-
ship and innovation is an important part of developing a stable and
resilient economy (Schramm 2006). The United States, in particular,
has seen a surge in public policy makers who view entrepreneurs as
critical players in economic growth efforts. Ironically, this comes at a
time when public resources are scarce and, thus, financial and other
resource support for entrepreneurs is waning. On the positive side, this
has led to greater collaboration and resource pooling between public
and private sector entities. One example of such collaboration is the
relationships being formed between universities and entrepreneurs.
University-entrepreneur collaborations fall under the umbrella concept
of academic entrepreneurship, which refers to the ‘efforts and activities
that universities and their industry partners undertake in hopes of com-
mercializing faculty research’ (Wood 2011, 153).
An example of academic entrepreneurship in action is NanoH20, a
company profiled in the Association of University Technology Managers’
(AUTM) The Better World Report from 2011. NanoH20 was founded to
commercialize a nanoparticle-infused membrane designed to purify
water. This venture is based on a technology discovered by Dr. Erick
Hoek, an environmental engineering researcher at the University of
California, Los Angeles (UCLA). The commercial application of his
discovery is water desalination plants because his process significantly
reduces the energy required to turn salt water into fresh water. Hoek
teamed with an entrepreneur and an industry scientist to license the
technology from UCLA, further develop the technology, seek capital

202
Governance for Academic Entrepreneurship 203

and develop the management team to launch the start-up venture. This
collaborative effort has yielded a very successful firm that is generating
financial returns for UCLA, the scientist and investors. The venture also
provides tremendous public benefit.
Success stories like NanoH20 are relatively rare (Agrawal 2006;
Benneworth 2001). Yet, academic entrepreneurship has become a priority
because universities are looking for new revenue sources. Universities
in the United States, for example, are faced with shrinking state and
federal tax dollars, and must find new ways to fund research activi-
ties. On the private industry side, turbulent and fast-cycle markets
(Sawhney and Prandelli 2000) are forcing entrepreneurs and growth-
minded firms to continually innovate. Thus, entrepreneurs need a
supply of ideas and technologies for new products. Also, universities
hold research-derived intellectual property that can be used as an
impetus for new product development (Etzkowitz 1998; O’Shea et al.
2004). When it works, academic entrepreneurship is a win-win situ-
ation because entrepreneurs capitalize on faculty members’ research
prowess, and universities capitalize on entrepreneurs’ ability to turn
technologies into marketable products and services that generate
revenue for them. As with most entrepreneurial endeavors, however,
success in academic entrepreneurship is elusive, and only a fraction of
universities realize meaningful returns on commercialized technologies
(Blumenstyk 2007).
There are numerous reasons for variability in academic entrepre-
neurship, so a number of scholars have developed descriptive and
normative models of university technology commercialization. Shane
(2004) provides seminal work that explains the role of university spin-
off ventures, Agrawal (2006) looks at university technology licensing
strategies and Wood (2009) explores the criticality of innovation
attributes. However, the richness of these contributions masks an
important gap in our understanding of the academic entrepreneurship
phenomena.
Specifically, the literature to date has been relatively silent on the role
of governance in facilitating or constraining effective university tech-
nology commercialization (Markman et al. 2008). This has important
implications because – as Wood (2011) illustrates – successful commer-
cialization requires a diverse group of stakeholders whose goals, inter-
ests and actions may not always align. Thus, if universities and private
enterprises are to engage in the collaborative processes associated with
academic entrepreneurship, new insights may emerge from discourse on
the role of governance.
204 Organizational Innovation in Public Services

University-industry innovation collaborations

In the United States, there has long been a view that public service organi-
zations are distinct. Specifically, public service organizations are to serve
the public good and advance society, as opposed to making a profit or
return on investment. Recent years, however, have seen a blurring of
the lines between public and private sector enterprises. This is evident
in the case of universities. In the United States, universities may be
public or private, but both are seen as serving for public welfare via stu-
dent education and the advancement of knowledge through research.
In terms of public universities, basic research has traditionally been
funded by taxpayer dollars through allocated funds or research grants.
In the past, the research discoveries from these grants (e.g., patents)
became the funding agency’s property. However, the 1980 Bayh-Dole
Act allowed the intellectual property generated under research grants to
become the property of the university. This legislation has been influen-
tial in enticing many universities to engage in commercialization activi-
ties (Carlsson and Fridh 2002; Markman et al. 2005). What this means
is that as university missions are extended to incorporate a greater com-
mercial orientation (Wood 2009), universities and private entities (such
as entrepreneurs) increasingly form collaborative relationships.

The academic entrepreneurship process

Wood (2011) recently outlined the commercialization process in some


detail, and he posits that academic entrepreneurship begins with a
university researcher’s discovery of a new innovation. At this point,
the new technology is very rough and largely a proof of concept. The
innovation is then disclosed to the university Technology Transfer
Office (TTO). As we discuss later, the TTO serves as the link between
the university and industry. TTO staff members are charged with the
difficult task of determining if the new innovation is worthy of intellec-
tual property protection usually by way of patents (Carlsson and Fridh
2002). This is a critical decision because the costs of securing a patent
can easily exceed $15,000 and take several years to finalize (Barringer
and Ireland 2010).
Once patent protection is secured, the TTO staff will begin to market
the technology and seek a relationship with an industry partner that
has the resources and expertise to develop the embryonic technology
into a market-ready product or service. Wood (2011, 157) argues that
this point represents an important transition to an external focus, where
Governance for Academic Entrepreneurship 205

the TTO must ‘balance and align the internal interests of the university –
including the researcher, if engaged – with the external interests of
entrepreneurs and other business partners’.
Once a preliminary partnership has been formed, the university and
its industry partner must determine the optimal organizational form for
commercialization. Although they are not always mutually exclusive,
the most commonly used forms are technology license agreements
and spin-off ventures. Technology licenses are arm’s length contractual
agreements that transfer the university’s innovation knowledge to an
outside party in return for a fixed fee or royalty (Agrawal 2006; Thursby
and Thursby 2007).
The license approach reduces risk for the university, but the a priori
value of early stage innovations is unknown, so cost/return ratios may
eventually prove inequitable for the university or the entrepreneur.
One way to overcome this problem is to launch a ‘spin-off’ firm that is
majority owned by the university and may or may not involve outside
partners (Shane and Stuart 2002). The advantages of spin-offs are that
they facilitate tacit knowledge transfer (Wood 2009) and often involve
the research scientist – sometimes as an equity partner (Feldman et al.
2002). The central drawback is that it requires considerable financial
and human capital.
In addition to the license and spin-off, some hybrid and informal
forms have been documented as well. Specifically, consulting arrange-
ments, joint publications with industry and university-industry interac-
tions all help facilitate innovation transfer (Colyvas et al. 2002; Link
et al. 2006). In some cases, informal interactions lead to the develop-
ment of hybrid arrangements, such as joint ventures and strategic alli-
ances. Take, for example, the creation of Joint Venture Spin-Offs ( JVSO)
where the university technology is ‘assigned or licensed into a new
company that is jointly owned by the university and the industrial part-
ner’ (Wright et al. 2004, 288). Wright et al. (2004, 307) assert that JVSOs
are a ‘fast and flexible route to commercializing university innovations
in comparison to university start-ups’. The downside to the JVSO model
is that stakeholders may have divergent interests and perspectives, so
behavioral controls are needed to manage JVSO partners (Siegel et al.
2003; Wright et al. 2004).
When viewed collectively, the various organizational forms have
unique advantages and disadvantages, so selecting the appropriate form
is a key success factor. In this regard, Wood (2009, 993) conceptualized
‘university-industry innovation transfer’ as a transaction and advanced
the idea that transaction and agency cost issues play a salient role in
206 Organizational Innovation in Public Services

organizational form selection. This has important implications because


successful commercialization requires the involvement of a diverse
group of stakeholders whose goals and interests may not always align;
therefore, governance considerations become salient (Wright et al.
2004). Unfortunately, as Markman et al. (2008) point out, the literature
to date has been relatively silent on governance’s role in academic entre-
preneurship. Thus, current thinking on academic entrepreneurship may
benefit from discourse on the role of governance in commercialization
transactions.

Commercialization transactions and governance

As the previous discussion outlines, the academic entrepreneurship


process involves moving into the realm of market transaction (Coase
1937). These transactions are needed because universities often lack
the skills, knowledge, and capabilities (in a coordinated aggregate)
required to turn research findings into marketable products or services
(Markman et al. 2008).
The conceptualization of university innovation commercialization
as a transaction (or a series of transactions) has yet to be empirically
validated. However, AUTM has published reports that support this
conceptualization. The 2009 AUTM Transaction Survey of 88 TTOs
(70 from the United States), for example, documents that TTOs hold
primary responsibility for managing technology licenses, transfer agree-
ments, nondisclosure agreements, and interinstitutional agreements.
The report also documents that TTOs sometimes develop other types
of transactions such as operating agreements for start-ups, revenue-
sharing agreements, royalty-monetization agreements and others. More
importantly – as title of the report highlights – the Transaction Survey
frequently uses the terms ‘transactions’ and ‘transaction agreements’ to
describe TTO activities. All of this suggests that university innovation
commercialization activities are indeed transactions.
If university innovation commercializations are transactions, then
they are subject to the risks, uncertainties and costs associated with all
market-based transactions (cf. Fama and Jensen 1983; Williamson 1981).
Many of these risks and uncertainties center on the alignment of stake-
holder interests and the threat of opportunistic behaviors by the parties
involved. Reducing these threats, and the costs of doing so, rests on
effective governance (Donaldson 2012). By extension, this means that
effective governance of university-industry transactions is likely to be a
key success factor in academic entrepreneurship. However, governance
Governance for Academic Entrepreneurship 207

in this setting is complex because universities’ organizational structures,


norms and cultures often differ from those of entrepreneurs and entre-
preneurial firms. Thus agreeing on governance models for overseeing
innovation commercialization transactions may be difficult because
each stakeholder may have very distinct ideas about how things should
be structured.

The university
The central actor in academic entrepreneurship is the university. In
terms of university governance, it is first important to understand that
governance discussions are typically focused on what happens when
the role of ownership (principals) and management (agents) are not
filled by the same person or group ( Jensen and Meckling 1976). When
this happens, there is a strong possibility that interests may misalign
and that the agent will engage in opportunistic behavior. Governance,
then, is about interest alignment and preventing opportunistic behav-
ior through oversight, incentive and punishment mechanisms (Amit
et al. 1990). Board of director representation (Fama and Jensen 1983),
contractual agreements (Williamson 1981) and performance incentives
(Beatty and Zajac 1994) are just a few of the mechanisms used to govern
principal-agent relationships.
While universities engaged in commercialization clearly develop prin-
cipal-agent relationships, the governance of these relationships has not
received much attention. As such, we draw on the work of Davis (2005,
143) to define governance within this context as the set of ‘legal, cul-
tural, and institutional arrangements’ that determine what universities
and industry partners can do, who controls them and ‘how risks and
returns from the activities they undertake are allocated’. In the university
setting, the governance of internal and external relationships typically
follows a ‘republic of scholars’ ideology such that decisions are made via
faculty and administrator consensus (Bleiklie and Kogan 2007, 477).
This type of collectivist decision making is indicative of the stewardship
approach to governance (Daily et al. 2003), where the assumption is that
agents will act in the organization’s interest because there is a strong
correlation between organizational success and that of the individual. In
other words, pro-organizational behavior trumps individualistic behav-
ior because the ‘steward perceives greater utility in cooperative behav-
ior’ (Davis et al. 1997, 24). However, at the school, department and
individual levels, we will soon see that the organization first assump-
tion often breaks down with devastating consequences for innovation
commercialization.
208 Organizational Innovation in Public Services

Research scientist(s)
Prior scholarship has established the important role research scientists
play in commercialization success (Nekar and Shane 2003; Thursby and
Thursby 2004). These are the individuals (or teams) who have discov-
ered the innovation concept, so they hold knowledge that is required to
develop the innovation from a proof of concept into a marketable prod-
uct or service. This means that, at a minimum, industry partners need
reasonable and reliable access to the research scientist (Link et al. 2006).
The reality, however, is that there is often little incentive for research
scientists to engage in commercialization activities.
These individuals are embedded in a structure that rewards reputa-
tional capital, which is built by publishing findings in highly prestigious
journals (Wood 2011). This means that there is often little incentive for
them to further develop their innovations or to participate in venturing
activities. Indeed, as much as 30% of commercialization efforts do not
involve the research scientist at all (Agrawal 2006). This is a reflection
of a clear and present governance problem where university systems’
incentive structures are not well-aligned with those who wish to com-
mercialize innovation discoveries (Laukkanen 2003).
The lack of a university governance structure recognizing the impor-
tant role that the research scientist plays in commercialization success is
both expected and surprising. It is surprising because the highest levels
of universities, university systems and governments in the United States
have publicly supported greater university and private industry collabo-
rations. For example, the University of North Carolina system Board of
Governors stated, ‘Our universities need to emphasize entrepreneur-
ship and leadership across all disciplines both inside and outside the
classroom’ (research.unc.edu/n/CCM1). However, there is a disconnect
between this statement and what actually happens on campus.
The individual faculty member/researcher is focused on tenure and
promotion objectives, which do not include ‘entrepreneurship’ or com-
mercialization as a metric. In that way, the lack of university govern-
ance enhancing commercialization success is expected because deans
and department colleagues who establish faculty incentives and weigh
in on promotion and tenure decisions have little reason to focus on
university-level entrepreneurship or commercialization. This means
that senior administrators assume that stewardship governance will
somehow facilitate the entrepreneurial objective, but the individual
researcher is focused on activities that advance their careers. In this way,
the current governance mindset is quite ineffective. As the cliché goes,
‘what gets measured and rewarded gets done’, and from a university
Governance for Academic Entrepreneurship 209

governance standpoint, commercialization activities are not rewarded


and, therefore, often do not get done.

Technology transfer office as boundary spanner


The hub of academic entrepreneurship is the TTO. Because university
commercialization happens at the boundary of the university’s organi-
zational structure, the university’s TTO fulfills the intermediary role
(Burt 1992). Thompson (1967, 67) called such intermediaries ‘boundary
spanning units’, and these units are designed to protect the organization
from uncertainties and contingencies in the environment. In that way,
the principal challenge for boundary-spanning units like the TTO is
adjusting to contingencies the organization cannot control (Thompson
1967). In the case of academic entrepreneurship, these contingencies
are primarily the actions of industry partners (e.g., entrepreneurs). As
such, university TTOs are faced with the daunting task of establishing
agreements that protect universities’ intellectual property, reduce the
risk of partner-driven contingencies and simultaneously support activi-
ties that result in revenue generation.
Making the contingency matter worse is the problem that most univer-
sity innovations are significantly underdeveloped in terms of commercial
application. For example, Marelize Botes, a university researcher whose
team integrated biocide fibers into industrial water filters, commented
that ‘when you test them, you don’t test them on an industrial scale.
You test in the lab so you can demonstrate the principle’ (AUTM 2011).
This illustrates the nascent proof-of-concept status of university innova-
tions and the implication is that TTOs and entrepreneurs face significant
challenges in determining an innovation’s commercial value and iden-
tifying contingencies that may arise. Organization theorists (Thompson
1967) and governance scholars (Williamson 1981) point out that estab-
lishing effective transaction governance under such conditions is very
difficult.
What all of this means is that TTOs are in a difficult position as they
try to align the interests of internal and external stakeholders based on
subjective evaluations of substantially underdeveloped technologies.
Add to this the high degree of variability in scientists’ involvement,
and the TTO is in the middle of a storm of ambiguity where clarity
is needed and expected. The practical effect of this situation is illu-
minated by comments by a bio-medical engineering faculty member
at a major research university in the United States. He discussed with
us how faculty members at his university have discovered potentially
path-breaking medical innovations but refuse to disclose them to the
210 Organizational Innovation in Public Services

TTO: ‘Not because they want to keep the innovation to themselves, but
because they perceive the TTO as slow moving and ineffective’. In other
words, university researchers feel that TTOs will not do much with their
innovations. This mirrors Siegel et al. (2003) findings and suggests that
important innovations are often not disclosed to TTOs. Hence, there
is clearly a breakdown of effective governance, and perhaps the most
disturbing effect is that society at large misses out on potentially life-
altering technologies.

The entrepreneur
In cases where TTOs have decided to commercialize patented technolo-
gies, they must attract external partners. Business partnerships can be
difficult to navigate, however, universities need the vision, skills, and
networks entrepreneurs use to enact entrepreneurial opportunities
(Thursby and Thursby 2004; Wood and McKinley 2010). This means
that as entrepreneurs unite with universities, the TTO must adopt a
‘multi-stakeholder perspective to align the internal interests of the
university with those of business partners’ (Wood 2011, 157). However,
interest-alignment is difficult because entrepreneurs are typically peo-
ple who think creatively, move quickly and embrace calculated risk
(Barringer and Ireland 2010). The literature suggests that entrepreneurs
are also well-aware of the agency costs that arise when self-interests
reign (cf. Arthurs and Busenitz 2003) and realize that agents must
be closely monitored to prevent opportunistic behavior (Williamson
1981). However, unlike the university ‘stewardship’ governance model,
entrepreneurs see the world through the ‘corporate governance’ lens
(Donaldson 2012). Corporate governance focuses on rent-seeking and
incentive systems to align the interest of owners, investors, managers
and other organizational stakeholders (Gibbons 2005). These arrange-
ments are typically authoritarian, directive and outcomes based and use
compensation packages (Beatty and Zajac 1994), equity exit agreements
(Aghion et al. 2004) and so on to align interests.
The advantage of the corporate governance model is that it clearly
defines relationships, expectations and reporting procedures as well as
addresses likely ‘what if’ scenarios (Davis et al. 1997). The disadvantage
is that a corporate governance focus on monitoring and outcomes does
not always work well in technology commercialization because entre-
preneurship is an evolutionary process with many uncertainties and
contingencies. Because of the nascent nature of university innovations,
these uncertainty and contingency problems are especially salient.
Despite this, the corporate governance model remains one of the more
Governance for Academic Entrepreneurship 211

dominant paradigms in entrepreneurial settings (cf. Klein 1999), and


this type of governance mentality reigns as TTOs and entrepreneurs
negotiate agreements. We are not suggesting this is necessarily bad, but
the opaque nature of technology commercialization makes it tough
for both TTOs and entrepreneurs to value the technology and prevent
moral hazard and hold-up incidents. Indeed, Agrawal’s (2006) research
on license agreements revealed that in 50% of the cases, the university
(licensor) got too little for their technology and that in the other 50%,
the licensee (entrepreneur) paid too much. While there are likely a
number of reasons for these outcomes, we suggest that a lack of effective
governance is one factor.

The investor
Despite receiving considerable attention in the broader entrepreneur-
ship literature, investors in the academic entrepreneurship context are
quite understudied. Rothaermel et al. (2007) comprehensively reviewed
and modeled the academic entrepreneurship literature, and it is notable
that their model does not include investors. Instead, they cite govern-
ment policy and industry conditions as the two salient external factors
discussed in the literature. In our view, this is a critical gap because turn-
ing university innovations into marketable products typically requires
extensive financial capital (Wright et al. 2004). Governments may
provide some initial funding (Patzelt and Shepherd 2009), but angel
investors (AIs) and venture capitalists (VCs) are increasingly seen as
important sources of capital in university commercialization (Wiltbank
et al. 2009). These investors are also important sources of knowledge,
reputation and network connections needed to develop new ventures
(Ahlstrom and Bruton 2006), and thus universities’ links with VCs
and AIs improve the odds of commercialization activities (Powers and
McDougall 2005).
Because only a few studies explicitly address investors in university
technology commercialization activities (cf. Wright et al. 2004), we
draw on the broader AI and VC literatures to develop a broad under-
standing of the types of governance models they favor. Our literature
review revealed that investors consider a variety of factors when making
investment decisions. For example, the entrepreneur’s prestige (D’Aveni
1990) and the attractiveness of the opportunity (Murnieks et al. 2011)
have been identified as key variables. However, investors are also con-
cerned about agency issues and, therefore, closely consider the degree
to which they have control over entrepreneurs’ actions (Gorman and
Sahlman 1989; Wijbenga et al. 2007). In short, AIs and VCs want to
212 Organizational Innovation in Public Services

ensure they have the capability to monitor and guide entrepreneurs’


actions as well as the strategic direction of the venture.
Applied to academic entrepreneurship, the literature suggests that – like
entrepreneurs – investors favor corporate governance models. However,
this group of actors appears to be even more focused on the threat of
opportunistic behavior and, thus, relies heavily on performance met-
rics to ensure entrepreneurs are making the most of their capital. This
means that once investors become involved, the relationships are even
more likely to be based on rent-seeking objectives, performance mile-
stones and incentive systems (Gibbons 2005), which may run counter
to the stewardship governance found in universities. This may indeed
make university-entrepreneur-investor relationships untenable.
Ensuring that capital is used effectively is clearly corporate investors’
top priority (Payne et al. 2009), and universities and entrepreneurs must
also employ contracts and other controls to protect themselves from
partners’ opportunistic behavior (Patzelt and Shepherd 2009). Thus,
monitoring and contracting costs begin to mount for all parties (Gulati
et al. 2000), and investors may see the complexities and governance
costs of academic entrepreneurship as too high. As such, attracting AI
and VC investment can be quite challenging for universities and aca-
demic entrepreneurs.

The alignment challenge

It is well-understood that transferring knowledge can be costly ( Jensen


and Meckling 1990), especially when goals are misaligned or when it
is difficult for the principal to verify the agent’s decisions and actions
(Eisenhardt 1988). In the context of academic entrepreneurship, knowl-
edge transfer requires universities, TTOs, research scientists, entrepre-
neurs and investors to align their objectives and decisions in a way that
everyone is moving toward the goal of successful commercialization
(Patzelt and Shepherd 2009; Shane 2004).
In our view, one of the more salient barriers to interest alignment – and
by extension, success in academic entrepreneurship – is the difference
between the governance model universities, entrepreneurs and inves-
tors use. As outlined earlier, universities tend to adopt stewardship
governance models (Davis et al. 1997), while entrepreneurs and inves-
tors tend to adopt corporate governance models (Donaldson 2012). The
former assumes that people will act in the organization’s best interests,
while the latter assumes that people will act in their own self-interests.
The crux of the matter, then, is that when universities begin to transact
Governance for Academic Entrepreneurship 213

with entrepreneurs and investors, there is a fundamental difference


in governance perspectives. Because the TTO is the principal bound-
ary-spanning unit responsible for such transactions, they are forced to
reconcile the two disparate governance models. This then raises the
question: on average, are TTOs structured in a way that facilitates inter-
est alignment and collaboration?
To investigate this question, we consulted a number of Web sites and
industry reports. What we discovered is that most TTOs are organized
as an extension of universities’ departmentalized structure. For instance,
AUTM’s 2009 Transaction Survey documented that 81 of 88 TTOs surveyed
reported that they were part of their institutional research infrastructure
and hence governed by the university hierarchy – subject to the norms,
policies and cultures of their university. In these cases, the governance
literature suggests that we would see a strong stewardship perspective
that feeds off the bureaucratic nature of universities. In that regard,
universities tend to focus on processes, policies and consensus-based
decision making, which can be slow and inefficient. This is a prob-
lem because entrepreneurs are naturalized in a corporate governance
model that emphasizes outcomes (instead of process) and expeditious
market-focused decisions. This puts TTOs at a structural disadvantage
as they try to bridge two very different mindsets (Benneworth 2001).
Thus, it appears that many TTOs are not structured in a way that
fully acknowledges differences in governance mindsets, so collabora-
tion with entrepreneurs and investors is not as effective as it could be
(Schramm 2006).
If we move from the general structure to the specific transaction, the
alignment challenge becomes even more salient. The use of technol-
ogy license agreements is ubiquitous in commercialization activities.
However, the high failure rate of such agreements (Agrawal 2006) sug-
gests that universities are not very good at making sure entrepreneurs
make decisions and take actions that will maximize the odds of success.
In a technology license, the university has appropriated the decision
rights to the entrepreneur largely because it does not want to shoulder
the risk associated with entrepreneurship (Kim and Vonortas 2006).
This means that activities such as product development, marketing and
seeking outside investment are functions largely controlled by the entre-
preneur. However, entrepreneurs’ judgments can be wrong, and because
the outcome of entrepreneurship is difficult to predict with certainty
(Shane 2008), it is tough for universities to know when entrepreneurs
are misguided. This is especially true when the entrepreneur’s activities
are loosely coupled (Thompson 1967) with those of the university. In
214 Organizational Innovation in Public Services

that way, technology license agreements are a gamble in which the uni-
versity is not only betting on the strength of the innovation but also on
the entrepreneur’s judgment and decision-making ability. The problem
is that if things turn out poorly, the university has no idea whether to
attribute the failure to the technology or the entrepreneur, which is a
significant governance issue rarely discussed.
In some cases, universities recognize that the issues associated with
technology licenses are too great and, thus, migrate toward hierarchical
governance via a university spin-off firm (Breznitz et al. 2008). Because
a university spin-off is a completely new business based on the univer-
sity’s innovation (Shane 2004), it is well-suited for novel technologies
that have uncertain commercial applicability (Wood 2009). Spin-offs
also appear to be good when the research scientist wants to be heavily
involved.
These individuals often want to profit from their discoveries and,
therefore, want to ensure that things are done in the proper way. Given
the governance limitations for technology licenses, spin-offs are better
suited for such monitoring. However, developing a successful spin-off
firm is difficult, and research shows that most ventures do better with
non-university surrogate entrepreneurs at the helm (Franklin et al.
2001). In that way, spin-offs reduce the agency risk of opportunistic
behavior but increase the entrepreneurial risks associated with lack of
experience (Wood et al. 2012), related knowledge (Haynie et al. 2009)
and reputation (Wood and McKinley 2010) that are key success factors
in entrepreneurship.

A new approach

Our discussions thus far have highlighted the role of governance in aca-
demic entrepreneurship, but the management literature suggests that
the alignment challenges and governance problems in academic entre-
preneurship are not particularly unique. As such, one possible avenue
to reconcile some of the governance problems outlined above would be
to utilize ‘hybrid’ (Makadok and Coff 2009) or ‘network’ (Larson 1992)
governance models.
Hybrid governance adopts ‘resources and/or governance structures
from more than one existing organization’ (Borys and Jemison 1989,
235), while network governance ‘involves a select, persistent, and
structured set of autonomous firms engaged in creating products or
services based on implicit and open-ended contracts to adapt to environ-
mental contingencies’ ( Jones et al. 1997, 914). The advantages of these
Governance for Academic Entrepreneurship 215

governance models are greater autonomy, adaptability, and integration


of both stewardship and corporate governance principles. However,
unlike entrepreneurs and investors, university TTOs and research scien-
tists are clearly not autonomous.
The TTO autonomy problem appears to be at the heart of a new
approach in the United States that may help facilitate hybrid and net-
work governance and, thereby, increase the odds of commercialization
success. Specifically, universities are setting up boundary-spanning TTO
units as limited liability companies (LLCs). In fact, AUTM’s (2009, 7)
Transaction Survey reported that 10 of 81 TTOs ‘functioned as separately
incorporated entities with their own boards of directors’. The idea is to
set up the TTO in a more autonomous way such that the TTO remains
accountable to the university but is less constrained by bureaucratic
controls and stewardship governance. In turn, this should allow the
TTO to develop more flexible agreements that provide contingency
adaptability when trying to commercialize unproven technology.
Because there is virtually no scholarly research on TTOs as LLCs phe-
nomenon, we interviewed the director of a U.S. public regional univer-
sity entrepreneurship center (EC), which houses the university’s TTO.
Our goal was to gain insight into why some universities are moving to
the LLC approach. The director reported that his university had recently
shifted their two-year-old EC/TTO to the LLC form under the assump-
tion that it ‘freed the center from some of the state rules and regulations
embedded in the university structure, and it also allowed the EC to hold
equity shares and make loans or investments in for-profit companies’
(e.g., start-ups that use university technology).
These comments suggest that the LLC form appears to be a vehicle
for liberating the TTO (or EC) from the university’s stewardship mindset
and more closely aligns it with the corporate governance model domi-
nant in private enterprise. Further, it allows the TTO to take on private
investors and to take an equity position in companies that license or
adopt the university’s patented innovations. These features of the LLC
form have important implications for the future of transaction govern-
ance in university technology commercialization.

Implications of the LLC approach


The implication of the LLC approach for transaction governance is that
we are much more likely to see the emergence of hybrid and network
governance models in commercialization transactions. The autonomy
created by the LLC form will allow the TTO to develop more collabora-
tive and open-ended contracts to coordinate and safeguard exchanges
216 Organizational Innovation in Public Services

( Jones et al. 1997). Because TTOs have focused more on protecting


intellectual property than on the coordination, adaption and consensus
building required to enact opportunities (Wood and McKinley 2010),
TTOs have been consumed with the legal aspects of their agreements.
However, Williamson (1991) posits that effective governance addresses
problems of adapting and coordinating. We suggest it is time for TTOs
to move beyond safeguarding to placing a greater emphasis on coordi-
nating and adapting. The TTO as an LLC appears to be a move in this
direction. In that way, TTOs, entrepreneurs and investors will be bet-
ter able to address the central economic problem of ‘rapid adaptation’
(Hayek 1945, 524).
A second implication of the LLC approach is that it provides a
mechanism by which the capital required for commercialization can
be gathered and injected. The LLC form allows for equity position
arrangements and private investment that can be channeled to com-
mercialization partners. This means that AIs and VCs can partner with
the university’s LLC on a new venture; invest in the LLC, which then
develops a portfolio of ventures based on university-held patents; or
invest directly in the venture without LLC affiliation. While investor
partnerships and independent investment have always been options,
the latter is made easier in the LLC environment. Moreover, investing
directly in the LLC, which then invests in a number of deals, is a new
arrangement that has not been available in the past. As such, it appears
that the LLC structure gives investors options and likely greater control
over agency threats (Gorman and Sahlman 1989) and entrepreneurs’
actions (Wijbenga et al. 2007), which have been shown to be key driv-
ers of investment decisions. Thus, the net effect is likely to be a greater
inflow of private capital into academic entrepreneurship.

Conclusion

In a perfect world, universities would simply commercialize their inno-


vations themselves and thereby reduce the need for transactions that
extend beyond organizational boundaries. Organizations must move
beyond organizational boundaries (to the market) when they lack
the capabilities to perform the required activities and in university-
entrepreneur relationships neither of these parties typically hold (in a
coordinated way) the requisite knowledge, skills and capabilities to go
it alone.
Broadly speaking, universities need entrepreneurs’ business acu-
men capabilities, and entrepreneurs need universities’ technological
Governance for Academic Entrepreneurship 217

innovations. However, these cross-boundary relationships are fraught


with potential problems. In this chapter, we outlined some of those
problems, discussed how the key players are likely to view managing
those risks via specific governance approaches, highlighted the differ-
ences in these perspectives and, finally, outlined an emergent approach
that may improve the efficacy of governance arrangements in academic
entrepreneurship. In doing so, the ideas presented in this chapter take a
step toward answering the call for a scholarly conversation on the role
of governance in university innovation commercialization.

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13
Governance and Accountability
of Joint Ventures: A Swedish
Case Study
Anna Thomasson and Giuseppe Grossi

Introduction

The purpose of this chapter is to analyze and understand accountability


and governance within joint ventures formed to provide public services
that are facing increasing demands due to new and more extensive legal
requirements and increasing demands from users regarding the type
and quality of the services delivered. At the same time, as the demands
are increasing, the financial situation in the public sector has in many
counties become more difficult, and due to large number of retirements,
there is a shortage of people with the right competences.
All these factors combined impose challenges on the provision of public
services, especially for smaller municipalities. In Sweden the solution for
smaller municipalities is often to collaborate with other municipalities in
the provision of public services (Argento et al. 2010). The type of collabo-
ration varies as regards the degree of collaboration, the actors involved
and the legal form used (Anell and Mattisson 2009). It is, however, more
and more common that smaller municipalities decide to merge organiza-
tions and create joint ventures responsible for the provision of a specific
type of service. Mergers are mostly found between organizations provid-
ing water and sewage services and waste management (Thomasson 2009),
but also other types of services are provided by joint ventures.
Also in other European countries (such as France, Germany and Italy)
collaborations of different kinds have emerged in the provision of public
services at central and local level (Grossi et al. 2010). During the last dec-
ades, through a strategy of investment or privatization by way of partial
disinvestment, governments or government-owned corporations have
often been involved in joint-ownership arrangements with other govern-
ments, non-government companies and other private partners (Thynne

221
222 Organizational Innovation in Public Services

1994; Wettenhall 2003). For decades this has been a prime option for
many small municipalities, which have established merged utilities.
By collaboration in joint ventures, municipalities can reach the scale
of provision required in order to gain economies of scale and scope.
Further, larger organizations tend to be more attractive employers, so
collaboration tends to facilitate the recruitment of employees with the
right type of competence. Also, the owners of the joint venture share
costs and risks, which enable development of the services.
However, collaboration in joint ventures or in other forms has
proved to be complicated (Bachiller and Grossi 2012; Bringselius 2008).
Research on different types of collaborations in different context and for
different services point toward the difficulty to overcome power imbal-
ances between the collaborating partners, to find common goals and
incentives, to align separate organizations with separate history and cul-
ture, to align stakeholder interests and secure stakeholder influence and
legitimacy (Ren et al. 2009; Ansell and Gash 2008; Hardy and Phillips
1998; Bryson et al. 2006). Legitimacy is perhaps especially important
when it comes to public sector services for which accountability is cru-
cial (Bovens 2009).
All the aforementioned challenges address issues that are related to
the corporate governance of organizations. Corporate governance con-
cerns the relationship between the actors involved in the governance
process (i.e., owners, board of directors and the managing directors).
Further, corporate governance concerns the rights and responsibili-
ties of these actors and the relationship between the organization and
its stakeholders (Aguilera 2005). A good corporate governance system
ensures a clear division of responsibility between the afore-mentioned
actors and also that they can be held accountable toward the stake-
holders of the organization (Clatworthy et al. 2000).
According to Ryan and Ng (2000) accountability in corporate gov-
ernance systems is about ensuring that boards of directors can be held
accountable toward shareholders. Others regard accountability to be
about securing the relationship between a principal and an agent (Gray
and Jenkins 1993; Sinclair 1995; Mulgan 1997; Hodge and Coghill 2007).
Corporate governance and accountability is thus closely linked, and it is
through the construction of the governance system that accountability
can be ensured. However, neither of the two considers the horizontal
relationships that emerge in the case of joint ventures.
According to Huse (2005), value is created in the relations between
the organization and internal and external actors, and this value is the
basis for the evaluation of the corporate performance. The definition of
Governance and Accountability of Joint Ventures 223

accountability applied here is therefore that of being able to hold some-


one responsible (accountable) for the performance of an organization
and in order to accomplish that the question of who is accountable to
whom and for what needs to be established (Bovens 2009).
The conventional focus of accountability was on the vertical relation-
ship, namely between the elected politicians and the citizens. Only
more recently has the question of who is accountable to whom emerged
as scholars came to realize that the market-oriented reforms introduced
in the wake of New Public Management (NPM) changed this relation-
ship (Humphrey et al. 1993; Rhodes 1994; Sinclair 1995; Deleon 1998;
Romzek 2000; André 2010). However, in order to secure accountability
in any organization the question of who is accountable to whom needs
to be established (Barberis 1998; Gray and Jenkins 1993). Accountability
has become multifaceted, involving account giving, holding to account
but also sitting in judgment, applying sanctions and being responsive
to citizens (Shaoul et al. 2012).
The focus of the corporate governance system is the vertical relation-
ship, that is, the chain of command. However, in joint ventures there is
not only a vertical but also a horizontal relationship (Kamminga and Van
der Meer-Kooistra 2007). The latter is that between the owners of the joint
venture. With more than one owner, several principals exist that want to
exert influence over the organization, and often the purpose with their
ownership differs (Child 2005). As joint ventures are ‘owned’ by different
independent local governments, control issues involve additional com-
plexities. Owners not only have to focus on the control of the joint ven-
ture itself but also on the relationship between the cooperating owner(s).
When constructing a governance system for joint ventures, it is thus
not enough to only focus on the vertical relationship: the horizontal
relationship also needs to be considered in order to overcome the chal-
lenges facing joint ventures as regards governance as well as account-
ability issues. The vertical relationship thus refers to the relationship
between the parents and the joint venture while the horizontal rela-
tionship refers to that between the parents themselves – the so called
inter-firm relationship (Kamminga and Van der Meer-Kooistra 2007).
The fact that there is not just one but two relationships add complexity
to the control of joint ventures.
First, we have the relationship between the parents and the joint ven-
ture, that is, the vertical relationship. Here, it is important for each of
the parents to be able to secure control of the joint venture organization
in order that the services delivered by the joint venture are in line with
the expectations and needs of the citizens in each municipality.
224 Organizational Innovation in Public Services

Second, we have the inter-firm relationship between the parents them-


selves. Accountability here is about securing an alignment of interests
between different parents (i.e., the different municipalities). They need
to ensure that the joint venture is delivering an output that is in line
with the expectations of each municipality as well as of their respective
citizens. Accordingly, the parents are not only accountable to the citi-
zens in their own municipalities, but also to those in the other munici-
palities. The experiences from Sweden show that joint ventures between
municipalities often fail due to the presence of divergent interests (Anell
and Mattisson 2009; Thomasson 2009). The different types of relation-
ship that emerge in joint ventures and their content is summarized in
Table 13.1.
Use of corporations for collaboration in the production of public
services has been a prime option for many small municipalities for
decades and has become more attractive in recent years (Grossi et al.
2010; Anell and Mattisson 2009; Torres and Pina 2002; Grossi and
Thomasson 2011). A local government can be anything from a majority
or dominant and active owner with a sufficient share of control over the
company, to a passive owner with little interest to exercise any form of
control. According to the Organisation for Economic Co-operation and
Development, ‘Government should act as an informed active owner
and establish a clear and consistent ownership policy, ensuring that the
governance of state-owned enterprises is carried out in a transparent
and accountable manner, with the necessary degree of professionalism
and effectiveness’ (OECD 2005, 13).

Table 13.1 Vertical and horizontal relationships in joint ventures

Type of Actors Accountability Governance


relationship involved focus focus

Vertical Between 1. Joint Venture To secure output


relationship parents and toward parents of the Joint Venture
the Joint 2. Each parent so it corresponds
Venture toward its citizens with the interests
organization of the parents and
other stakeholders
Horizontal/ Between the Securing alignment Governing the
inter-firm parents of the between the interests of parent-parent
relationship Joint Venture all parents: a prerequisite relationship:
for governance of the aligning interests
vertical relationship and incentives
Governance and Accountability of Joint Ventures 225

According to Shaoul et al. (2012), however, the public sector has dif-
ferent and potentially conflicting corporate governance and account-
ability relationships to manage compared with the single driving
relationship between the board and shareholders that is the focus of
private sector corporate governance. Thynne (1994) emphasizes the dif-
ficulty in achieving the right balance of autonomy and control in order
to secure accountability, but without compromising the performance of
the corporation. These challenges are mainly related to the corporate
governance of governmentally owned corporations (Thomasson 2009;
Luke 2010).
Corporations that are jointly owned also face challenges that can be
attributed to the fragmented ownership and the need to respond to
the interests of more than one owner at the same time (Child 2005;
Kamminga and Van der Meer-Kooistra 2007). With more than one owner,
several principals want to exert influence and control over the organiza-
tion, but often the purpose for their ownership differs. As joint ventures
are ‘owned’ by different independent local governments, control issues
involve additional complexities. Owners not only have to focus on the
control of the joint venture itself, but also on the relationship between
the cooperating owner(s). Therefore, the question of accountability in
governmentally owned corporations with fragmented ownership is not
only restricted to the vertical relationship between the owners and the
company but also encompasses the horizontal relationship, that is, the
relationship between the owners.

Theoretical framework

The theoretical framework for accountability in joint ventures encom-


passes three different parts: first, the governance of the vertical relation-
ship, between the parent and the joint venture; second, the governance
of the horizontal inter-firm relationship; third, the question of what the
joint ventures and the owners are accountable for.
According to political economic theory, an enterprise owned by more
than one large shareholder would perform better than an enterprise
owned by one municipality. Jointly owned enterprises have more
protection from political pressure than do enterprises owned by one
municipality (Bachiller and Grossi 2012, 69). If we look at corporate gov-
ernance theory instead, it is suggested that dispersed ownership creates
a loss of ownership control and inferior performance. This effect may be
stronger in inter-municipal enterprises, as ownership control becomes
further diluted and weak (Sorensen 2007). It is the responsibility of the
226 Organizational Innovation in Public Services

owners to establish appropriate tools for steering, coordinating and con-


trolling municipal corporations (Grossi and Thomasson 2011).
Related to the question of control is the question of what to control. The
performance dimensions which are of major interest to the owner(s) is that
of economy and efficiency, while the local government (as purchaser) is
also interested in nonfinancial performance, as it focuses on effectiveness
and quality of services (Power 1997; Reichard 2006). The OECD suggested
that ‘all SOEs [state-owned enterprises] should disclose financial and non-
financial information, and large and listed ones should do so according
to high quality international standards’ (OECD 2005, 43). Thus, due to
the combination of diverging features and interests identified by Thynne
(1994) and others, there is not only a question of how to control but also
a question of what to control. What should be the focus? Is it financial
performance or the ability to deliver high quality public services?
In spite of the challenge of having to deal with one horizontal and one
vertical relationship in the joint venture, the owners also have to face
the challenge of combing different performance measurements that are
not always compatible. This further complicates the question of govern-
ance for accountability in joint ventures between local governments.
Thynne (1994) presents a framework for analyzing the control of
governmentally owned corporations. This framework consists of four
different aspects. The first is ownership and internal control in the pres-
ence of joint ownership. The second is top management with a focus
on the composition of the board of directors. The third is the financing
of the corporation. The fourth is the external control that focuses on
the laws and regulations to which the corporation is subjected.
We focus on the first three aspects: the internal (not external) aspect.
We do this by analyzing how these three aspects are considered in the
horizontal as well as the vertical relationship. We combine aspects from
Thynne (1994) regarding the creation of accountability in governmen-
tally owned corporations with those characteristics specific to joint-
ventures in Kamminga and Van der Meer-Kooistra (2007).

Research method

In order to achieve the purpose of this study, which is to analyze and


understand how accountability is created in joint ventures, a qualitative
oriented case study method has been chosen. The case study method
allows for a phenomenon to be studied within its context (Eisenhardt
1989) and for the in-depth studies required when complex social phe-
nomena are to be explored (Bryman and Bell 2003).
Governance and Accountability of Joint Ventures 227

The gathering of empirical material was conducted through semi-


structured interviews with the CEO, directors on the board and repre-
sentatives of the owners (politicians on the Municipal Executive Boards).
The reason for choosing these individuals was the focus of the study on
the internal aspects identified by Thynne (1994) as well as the vertical
and horizontal relationships identified by Kamminga and Van der Meer-
Kooistra (2007). The questions asked during the interviews were developed
in accordance with this framework and with a focus on capturing these
accountability relationships and aspects. The empirical data gathered were
analyzed after the interviews with a focus on the aforementioned aspects.

Case description

VoB is a municipally owned corporation that, since the beginning of


2004, is owned by the 33 municipalities in the Region of Skåne, together
with 8 municipalities in the Region of Kronoberg, both situated in the
south of Sweden.
The corporate name is a short for ‘Care and Housing’ in Swedish,
these being the services the corporation provides to their customers.
The municipally owned corporation is intended to be an alternative to
the private operators on the market and to secure the provision of the
services. The focus is especially on securing the provision of housing for
emergency situations and short-term needs, which are the services that
are most costly to provide and therefore less attractive for private corpo-
rations to supply. The services are, according to the owners’ directive, to
be provided with high quality and in a business-oriented manner.
The customers are the official administrators at the social service offices
in the municipalities. The official administrators are thus the purchasers
of the services provided by the corporation. Besides housing and care,
the corporation also provides services in terms of investigations of the
type of support these families and the children need as well as provide
housing and care for young immigrants that come to Sweden without
their families.
The municipalities do not have to choose VoB when purchasing serv-
ices: they can choose to buy the services they need from whichever cor-
poration they wish. The services provided by VoB are thus subjected to
competition and the corporation has several competitors, especially for
nonemergency services such as long-term housing and care. Furthermore,
bigger municipalities with more capacity have in-house provision as
well. This means that VoB has competitors and so not all owners use it.
The competition is further enhanced since the relationship between VoB
228 Organizational Innovation in Public Services

and the municipalities is organized so that each new order requires a


new contract, meaning that there is no long-term commitment between
the municipalities and VoB.

The history of the joint venture


The corporation was first created by the eight municipalities in Kronoberg
in 1992. The reason behind the creation of the corporation and the deci-
sion to form a joint venture was that the eight municipalities could not
find housing and care for children with acute needs. The number of
places provided by the county or by private operators was not sufficient,
especially costly short-term places. The municipalities therefore decided
to start their own alternative and formed VoB Kronoberg.
While the issue regarding collaboration to solve housing and care was
raised already in the 90’s in the county of Kronoberg, it was first around
year 2000 that the same issue became subject for discussion among the
municipalities in the neighboring county Skåne. Until then, the County
had provided housing and care for the aforementioned groups of peo-
ple, but due to its internal reorganization, it was no longer interested
in doing so. The County Council thus asked the municipalities if they
wanted to take over the existing services and facilities.
A discussion took place within the Association of Local Authorities
in Skåne and the politicians on the board of this association decided
that they, in order to manage the costs, needed also to collaborate with
municipalities outside the region of Skåne. At the same time as the
municipalities in Skåne were having this discussion, the owners of VoB
Kronoberg started to discuss the need to expand and invite more owners
in order to make the provision of the services more efficient.
A dialogue between the owners of VoB Kronoberg and the Association
of Local Authorities started, and this was the beginning of the creation
of a new and larger VoB – this time with 41 owners. Once the new cor-
poration was in place the process of taking over the facilities from Skåne
County started.
The corporation has, with the exception of the first couple of years,
performed well financially, and the board members and owners are
satisfied with the results. The vice chairman stated the following during
an interview:

There are no draw-backs with collaborating with other municipali-


ties. Rather it is a necessity to do so, especially for smaller munici-
palities who cannot provide the services themselves and this goes for
several of the municipal services and is not only the case with the
services provided by VoB.
Governance and Accountability of Joint Ventures 229

Thus it seems that collaboration in a joint venture solves the problems


the municipalities have individually with financing and securing the
supply of the services provided by VoB.

Governance structure and financial solution


The 41 municipalities are not directly involved in the ownership
and the governance of the corporation. Instead, the responsibility
for ownership is delegated to the Association of Local Authorities in
Skåne, together with the Joint Government Council in Kronoberg.
The municipalities in Skåne are members of the Association of Local
Authorities in Skåne and appoint directors to this association. The
solution is similar for the Joint Government Council in Kronoberg.
The members of these boards are then responsible for the govern-
ance of VoB. When the joint venture was created, it was decided
that the shares of the corporation should be divided equally between
Kronoberg and Skåne; accordingly, each owns 50% of the corporation.
In line with this, Skåne and Kronoberg appoint four directors each to
the board. This means that the Skåne Association of Local Authorities
appoints four directors and so does the Joint Government Council of
Kronoberg.
According to the Chairman of the Board, the reason for why they
decided to divide the shares equally between the owners even though
Skåne has more municipalities was that they regarded it as being two
owners with equal interests in the corporation; therefore, they should
each have an equal stake. For the same reason, the decision was made
to have an equal number of representatives on the board and to alter-
nate the chairmanship between Skåne and Kronoberg. According to the
chairman, this arrangement has:

Facilitated the co-operation and helped everyone to focus on what


is best for the corporation. An even power balance is important in
order to make the collaboration work.

The Chairman and Vice-Chairman of the Board are of the opinion that
there is no confusion about roles and that the ownership role and the
customer role are clearly separated. The separation of roles is facilitated
by the fact that the ownership is delegated to The Association of Local
Authorities in Skåne and the Joint Government Council of Kronoberg,
while the customers are the social services in each of the 41 munici-
palities. The 41 municipalities are therefore never really involved in the
governance process and this prevents confusion of roles and municipal-
ities overstepping their boundaries as owners so that they do not start
230 Organizational Innovation in Public Services

to micromanage the corporation. Further the customers are the social


services and not the politicians on the Municipal Boards. According to
the CEO, it would have been more difficult to manage VoB if the situa-
tion had been different.

If the corporation was financed by tax money or if the customer-


corporate role was less clear, the ambiguity would have been larger
and it would have been more difficult to secure the quality of the serv-
ices and work with improving the efficiency in the organisation.

This distance has also, according to the CEO, influenced the role of the
board.

The board meets in places other than in their own municipalities or


in their so-called backyard. This prevents them from trying to get
too involved in the daily activities or what are my responsibilities.
There is thus a distance between the daily operations and the board
members, and they do not know so much about the details of the
services.

However, sometimes the distance is too large. During the interview the
CEO pointed out how several of the municipalities and administrators
purchasing services from VoB do not even know that they own the
corporation. This is supported by statements from the Chairman and
the Vice-Chairman as well as by information provided during inter-
views with the owners. When talking to politicians on the Municipal
Executive Committee in two of the 41 municipalities, it became evident
that even if they knew about the corporation few of them were well-
informed about VoB. If they knew more about the corporation, it was
often because they were representing their municipality on the board of
the Association of Local Authorities in Skåne or the board of the Joint
Government Council in Kronoberg.

Control and accountability


The control of the corporation is conducted by the members of the
board of VoB. The board in turn relies to a large extent on the informa-
tion provided by the CEO and the reports he provides them with. The
board receives reports on a regular basis regarding the financial perform-
ance, the number of vacancies and the level of quality.
Early on in the collaboration, the decision was made to implement
a quality control system in the corporation. The reason for this was
Governance and Accountability of Joint Ventures 231

twofold. The first reason was to secure the desired quality of services pro-
vided and the second was to align the culture in the different facilities in
order to have the employees work toward the same goals. To introduce
a quality control system was, according to the Chairman of the board,
important, since:

the system was new for everyone and not something that one organi-
sation took over from the other.

To implement the quality-control system was one important step to


bring the organizations in the joint venture together, but also to have a
system for measuring the performance of the corporation.
Another control system that has been introduced is a questionnaire
that is given to the customers after the completion of a purchase. The
results of this customer survey are given to the administrators at the
social services, the purpose being to learn more about customer satisfac-
tion and how VoB can improve its services. The results are also reported
to the board.
Another mechanism of control is the audit, auditors being appointed
by the owners. The external as well as the politically appointed auditors
(which are internal and appointed by the Skåne Association of Local
Authorities and the Joint Government Council in Kronoberg), report
back to the board on an annual basis. The politically appointed audi-
tors are well-informed about the corporation and have, according to the
CEO, made regular visits to the facilities. It is interesting to note here
that the owners, that is, the 41 municipalities, have never requested
more information than the corporation provides.

Discussion and results

Our discussion now focuses on ownership and internal control, com-


position of the board of directors, the financing of the corporation, all
within the horizontal and vertical relationship.

Vertical relationship
The control of VoB is focused on the use of traditional governance
mechanisms. The owners appoint members to the board and the board
controls the CEO and evaluates the performance of the corporation
based on reports from the CEO and the auditors.
More interesting is how the relationship between the corporation and
the owners is constructed. The control over the corporation has been
232 Organizational Innovation in Public Services

handed over by the local government to two separate organizations.


Consequently, none of the local governments has direct control over
the corporation or over the appointments of board members. Another
effect of this solution is that there is a clear separation between the
ownership role and the purchasing role. Each local government is only
indirectly involved in the ownership and responsibility for purchasing
lies with the social services administrator. Thus, the financial solution
chosen further separates the role of owner and purchaser as suggested
by Reichard (2006).
This solution has rendered the corporation to be more autonomous
and less dependent and affected by the political development in the
local governments, which supports the findings of Bachiller and Grossi
(2012).
On the one hand, this has been good for the corporation and enabled
the CEO to develop the corporation and also enabled a clear division of
role between the ownership and purchasing functions, thus facilitating
performance measurement (Power 1997; Reichard 2006). On the other
hand, the chosen solution risks impairing the ability of the owners
to secure accountability. In the case of VoB this risk has partly been
overcome by the fact that the corporation is certified and a perform-
ance measurement system is in place. However, the problem is that the
owners seem not to be interested in following up on the performance
of VoB, in either their capacity as owner or as customer.

Horizontal relationship
The horizontal relationship can be divided into two parts. On the one
hand, we have the relationship between all 41 owners; on the other
hand, there is the relationship between the two groups of owners. The
corporation is also constructed so that the division of shares and number
of members on the board is divided equally between the two groups of
owners. This gives the two groups an equal stake in the corporation and
has contributed to the fact that they are both striving toward what is in
the best interest of the corporation. Consequently, less focus is directed
toward the interests of each owner, as is otherwise the risk with joint
ventures.
What has also facilitated the alignment of interest between the owners
is how the governance of the corporation is organized, so that the owners
interact on two different levels. The first level is found in the two organi-
zations that make up the ownership, VoB Kronoberg and the Association
of Local Authorities in Skåne. At this level, the representatives from the
local government in Skåne do not interact with representatives from
Governance and Accountability of Joint Ventures 233

the local government in Kronoberg. These forums are, thus, to align the
interests of the local governments in each region: accordingly, they are
composed of representatives from the local governments.
The second level is the board level. At this level, the representatives
appointed to the board by each owner interact during the board meet-
ings. This is the level where representatives of all the owners meet.
However, this forum is also composed of selected members from the
local governments in each region and it is only a fraction of the owners
that have a political representation on the board.
It is at the second level that decisions are made regarding how to
evaluate the corporation and what types of performance measurements
are to be used for this evaluation. Here, we find financial performance
measurements as well as evaluations focusing on non-financial perform-
ance (such as capturing the level of quality of the services provided).
Thus, performance measurement is a reflection of the directives given
by the owners stating that the corporation is to deliver social value in a
more business-oriented manner.
The analysis of the horizontal relationship shows few signs of the
conflict of interests between the owners that is often the case in joint
ventures (Child 2005; Kamminga and Van der Meer-Kooistra 2007). The
reason for this is probably that the majority of the decisions are made at
the second level (that is, the board), and not all owners are represented
here. Thus, many issues are never raised in the local governments. This,
of course, increases the ability to reach alignment of interests.
There is thus a distance between the owners, the corporation and the
local governments. On the one hand, this appears to facilitate the inter-
firm relationship; on the other hand, the organizational structure makes
it more difficult to define who is accountable to whom with the corpo-
rate structure chosen.
Also, the question of what the corporation is to be accountable for
can also be discussed. There seems to be no apparent conflict of inter-
est in regard to performance measurement. However, the corporation
is and has been financially stable and has no apparent problems. There
has, thus, not been any reason to raise the question of what the corpo-
ration is to deliver and if the business-oriented focus of the corporation
has a negative influence on public value.

Concluding remarks

One conclusion that can be drawn from the case studied here is that
the organizational solution and the corporate structure facilitate the
234 Organizational Innovation in Public Services

horizontal relationship as well as the vertical relationship and also the


balance between autonomy and control.
In the horizontal relationship, the control is facilitated since there is
a clear separation between the purchasing role and the ownership role.
This also makes it easier to answer the question of who is accountable
to whom and, thus, facilitates the creation of accountability in the rela-
tionship between the municipal corporation and its customers.
However, in order to accomplish this, it seems like there has to be a
distance between the ultimate owners (local governments) and the cor-
poration because the local governments in the case of VoB only own the
corporation indirectly, and this makes its accountability to them more
difficult.
In the vertical relationship, this indirect ownership has reduced the
potential for conflict of interests between the owners and, consequently,
given the corporation more autonomy and the board more power. In
one aspect, this has facilitated control over the corporation by the
board. However, it also makes it more difficult to secure accountability
since the ultimate owners’ influence over the corporation is reduced.
There is clearly a need to find a balance between autonomy and
control in the governance of government-owned corporations. Control
increases accountability, but too much control could impair perform-
ance. In joint ventures, this seems to be as true for the horizontal rela-
tionship as for the vertical relationship, but for different reasons. In the
vertical relationship, there is a need to secure control, and for this, the
owners need to be present. In this relationship, it is about governance,
and it secures a favorable outcome.
In the horizontal relationship, there is a risk of a conflict of inter-
est and thus control could actually be facilitated if there is a distance
between the ultimate owners and the corporation. Also, this distance
improves performance since it reduces the potential conflict of interests
in regard to desired outcome and conflicts between different objectives.
Or, at least, it creates an illusion of there being an alignment of interest.
However, since there is a distance between the ultimate owners and the
corporation, this impairs their ability to secure accountability.
Another conclusion that can be drawn from this single case study is
that there is a difference between what to focus on in the horizontal
relationship and in the vertical relationship and that these points of
focus are not always compatible. What creates accountability in one
relationship impairs accountability in the other. Accordingly, there
seems to be a need to balance between accountability, on the one hand,
and the management of the inter-firm relationship and performance,
Governance and Accountability of Joint Ventures 235

on the other. In other words, in order to secure accountability in joint


ventures, the horizontal as well as the vertical relationship needs to be
taken into account. However, more studies are necessary in order to be
able to make any general conclusions on the creation of accountability
in joint ventures.

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14
Contractual Governance:
A Social Learning Perspective
Peter Vincent-Jones

Introduction

This chapter focuses on contractual relationships between public


authorities and other state or independent sector bodies, taking the UK
National Health Service (NHS) as the main case study. The governance
issues posed by contractualization in fields such as health and social
care differ from those arising in traditional public procurement or in
the outsourcing of ancillary services such as cleaning and buildings
maintenance.
‘Contractualization’ here refers not only to the changing nature of
economic relationships involved in public service provision but also to
the use by the state of contract as a means of achieving specific policy
objectives such as improving efficiency and effectiveness, reducing the
size of public bureaucracies, transferring public service functions out of
the state sector and increasing the role of private and voluntary provid-
ers. Examples of contractualization in Britain since the 1980s include
the introduction of compulsory competitive tendering (CCT) in local
government, the financing of public infrastructure projects through the
Private Finance Initiative (PFI) and the creation of the internal market
in the NHS.
The term ‘new public contracting’ (NPC) describes this mode of
governance, characterized by the delegation of contractual powers and
responsibilities to public agencies in regulatory frameworks preserving
central government controls and powers of intervention (Vincent-Jones
2006). While governments after the Second World War had pursued pol-
icy goals of industrial restructuring and regional development through
public procurement (Smith 1971), and ‘contract compliance’ was used as
an instrument for changing behavior in respect of employment practices,

238
Contractual Governance 239

race and sex discrimination and environmental protection (Arrowsmith


1995; Morris 1990),1 the more fundamental purpose of the NPC in the
last quarter of the twentieth century and beyond has been to promote
the transition from bureaucratic to non-state financing and provision of
public services through increasing exposure to competitive processes.2
This chapter explores the potential for social learning in contract-
ing for public services with specific reference to healthcare in Britain.
After a brief outline of contrasting strategies for NHS reform within
the UK since devolution, we show how the analysis of contractualiza-
tion in this context may be undertaken on the basis of a combined
relational contract/social learning perspective. The basic argument is
that relational contracting is a precondition of effective social learn-
ing in all contractual relationships, including those in public service
quasi-markets. However, other institutional conditions must be satis-
fied in order for public contracts to serve legitimately as mechanisms
for problem-solving in the public interest, including the building of
capacities for democratic participation on the part of citizens and stake-
holders. We further suggest that while policy and regulatory frameworks
may help facilitate the conditions necessary to promote social learning
through contracts, they may also serve as obstacles to that end. These
dimensions of reflexivity are illustrated in the case study analysis of
governance by contract in the NHS in England and Wales.

Governance by contract in quasi-markets

Governance by contract is at the heart of quasi-market organization in


which public authorities purchase services on behalf of citizen consum-
ers from competing service providers (Le Grand 1995; Wright 2010).
As in routine public procurement, public bodies enter into contracts in
accordance with domestic and EU legal obligations and conditions spec-
ified in centrally imposed regulatory frameworks. Here the ‘horizontal’
contractual relationship between the public agency and service provider
is nested within ‘vertical’ or hierarchical relationships with various
tiers of government (Goldberg 1976; Zumbansen 2003). Economic
coordination occurs through the devolution of contractual powers to
commissioning agencies under competitive conditions in which policy-
informed ‘choices’ have to be made, for example concerning the form
of provision, the identity of the supplier and the trade-off between
price and quality. While hierarchical ordering of some kind is neces-
sary to help generate dynamic efficiency, the overall responsiveness of
quasi-markets is dependent also on the active participation of citizens
240 Organizational Innovation in Public Services

and service users, which may be essential for allocative efficiency. Since
in conventional quasi-market organization consumers cannot exercise
choice directly, public participation is vital to producing services ‘that
individual users value and in the quantity and quality that they prefer’
(Jackson 2001, 18). Here the concept of ‘performativity’ refers ulti-
mately to ‘the capacity of a contractual system to generate added value
for the stakeholders’ (Davis 2007, 387). In another quasi-market variant,
consumers may exercise choice directly in publicly funded vouchering
schemes. In this instance the role of the state, either instead of or in
addition to service commissioning, is to establish the scheme and over-
see the operation of contracts between citizens and service providers
(Le Grand 1995).
Quasi-markets in some form have become widely accepted as a means
of increasing efficiency and improving quality in tax-funded healthcare
systems. However, the precise nature of the mix of bureaucratic and
market elements – and in particular the role accorded competition and
market incentives in structural reforms – have been hotly contested.
After 2000, in the wake of political devolution to Wales, Scotland and
Northern Ireland, there has been significant policy divergence in the
four home countries from the common baseline of the ‘internal mar-
ket’ established throughout the NHS in the 1990s. While England has
sought to intensify quasi-market competition and increase independent
sector involvement, the other three UK territories have opted either
to retain a softer version of the purchaser/provider split (as initially
in Wales) or to abolish the split and revert to bureaucratic integration
(the path taken by Scotland and recently also by Wales). Devolution
has therefore created the conditions for a ‘natural experiment’ with
different forms of governance that is relevant to other publicly funded
healthcare systems beyond the UK, for example in countries such as
Norway and New Zealand (Hughes and Vincent-Jones 2008, 413). This
account of governance by contract in the NHS focuses in particular on
the comparison of ‘hard’ and ‘soft’ versions of quasi-market organiza-
tion in England and Wales, respectively, in the period before the most
recent Welsh reforms have taken effect.

Social learning and reflexive governance

The central role of social learning in decision-making and problem


solving in the public sphere is explicitly recognized in the contempo-
rary legal-philosophical theory of reflexive governance as social learning
(De Schutter and Lenoble 2010; Lenoble and Maesschalck 2010). This
Contractual Governance 241

distinctive perspective draws elements from various strands of existing


social learning theory, most notably in the literature on organizational
learning (Argyris and Schön 1978; Schön 1983; Easterby-Smith 1997);
deliberative democracy (Goodin and Niemeyer 2003; Strydom 1999);
experimentalism (Sabel 1994); and (to a lesser degree) transformative
learning and policy learning (Mezirow 2003; Peterson 1997; White
2000). According to Lenoble and Maesschalck (2010), the most intrac-
table governance problems can ultimately be resolved in the public
interest only through social learning strategies aimed at maximizing
the fulfillment of normative expectations of participants in a collective
action. The term ‘normative expectations’ here refers to either what the
participants believe should be done or gained, or how the interests with
which they are concerned should be met. Social learning involves spe-
cific kinds of communication, deliberation and reflection by all parties
with interests or stakes in the issue in question. Transcending the dual-
ism of markets/neo-institutionalism and bureaucracies/state welfarism,
the emphasis is on the need to create institutional conditions that help
facilitate reflexive problem solving on the part of key actors engaged
in decision-making on matters of public interest. These conditions are
argued to take three main forms: (1) economic-institutionalist (concerned
with increasing efficiency), (2) pragmatist (involving experimentation
with different forms of joint enquiry such as benchmarking and learn-
ing by monitoring) and (3) democratic-deliberative (enhancing dialogue
through increased representation).3 Beyond the present concern with
public services, this perspective has been applied in other fields such
as energy (Prosser et al. 2010), biodiversity (Dedeurwaerdere 2010) and
corporate governance (Deakin and Koukiadaki 2010).
Following this approach, social learning in quasi-markets may be seen
as occurring through multiple, communicative relationships between
professionals, employers, employees, purchasers, providers, service
users and other stakeholders. The exchange of information contributes
a vital resource for decision-making at each node in the public service
network (Burris et al. 2005).4 While the contractual relationship between
commissioners and service providers is a key site of social learning, the
reflexivity of the system as a whole is dependent both on how this rela-
tionship is framed by the hierarchical dimensions of governance, and
on the involvement of citizens and service users in decision-making
processes.
First, a basic task for institutional designers is to improve efficiency by
altering incentives among economic actors (Le Grand 1995). The social
learning capacities of clients and contractors are structured by economic
242 Organizational Innovation in Public Services

regulation, which should help enable decision-makers develop solutions


to governance problems that maximize efficiency and minimize trans-
action costs, thereby satisfying at least to some extent the economic
dimension of the public interest. However, well-documented problems
with quasi-market organization (monopoly power, bounded rational-
ity, asymmetric information, externalities and agency) limit what may
be achieved through learning based solely on economic rationality.
In any case, this economic-institutionalist conception tends to ignore
wider considerations such as the need to take account of the interests
of consumers and citizens who are outside the principal contractual
relationship.
Second, and in part for this reason, decision-makers must avoid
rational-technocratic assumptions and adopt instead a pragmatic
approach that acknowledges the need for continuous revision of basic
assumptions underpinning the provisional goals and problem-solving
strategies of their part of the organization (Argyris and Schön 1978).
Commissioners and providers of services may thus be seen as collectively
engaged in continuous discussion of joint goals in situations of uncer-
tainty and limited understanding. The nature of governance problems
and the interests of these key players cannot be assumed to be fixed but
are rather negotiated, defined and redefined through collective engage-
ment in various communicative, deliberative and experimental prac-
tices. The parties must learn to avoid repetitive and defensive patterns
of thinking associated with single-loop learning and engage in frame
reflection involving double-loop learning: ‘Double-loop learning occurs
where error is detected and corrected in ways that involve the modifi-
cation of an organization’s underlying norms, policies and objectives’
(Argyris and Schön 1978, 3). There is an ongoing requirement for deci-
sion-makers to engage in forms of inquiry which ‘resolve incompatible
organisational norms by setting new priorities and weightings of norms,
or by restructuring the norms themselves together with associated strat-
egies and assumptions’ (18). Relationships are predicted to fail where
their fundamental assumptions and routines become self-reinforcing,
and single-loop learning inhibits the detection and correction of error
(Argyris 1982).
Third, in order for collective learning effectively to reflect the public
interest, it is necessary for commissioners and service providers to draw
on the greatest possible pool of knowledge and experience in their
efforts to resolve governance problems. The active participation of citi-
zens and service users serves as a vital resource in this regard (Mullen
et al. 2011). In human service sectors such as health and social care,
Contractual Governance 243

patients and consumers are also coproducers. They may help resolve
problems by raising issues and posing questions that professionals have
not considered (Tritter and McCallum 2006). Effective public engage-
ment entails constructive dialogue aimed at reshaping the relationship
between professionals, managers and other stakeholders (Mullen 2008).
The state has an important role to play in fostering such basic condi-
tions of social learning. Government interventions may help build
capacities for citizens and service users to contribute in various ways, for
example by providing education and training opportunities and devel-
oping communicative skills necessary for their effective involvement
(Vincent-Jones et al. 2009). The state can play a part also in establish-
ing appropriate democratic fora of participation and deliberation, and
in creating an institutional framework for incentivizing key decision-
makers such as commissioners and service providers to listen and be
receptive to stakeholder input.
The challenges to realizing this vision of social learning in public
service quasi-markets may be considered in the context of the NHS in
England. Recent legislation has created an elaborate regulatory frame-
work in this field which might, in principle, provide a basis for reflexive
governance. Independent regulatory agencies (Monitor and the Care
Quality Commission) have acquired extensive new powers to regulate
for quality, choice and competition. Under the Local Government and
Public Involvement in Health Act 2007, Local Involvement Networks
(LINks) have been constituted as representative bodies in 150 local
authority areas in England, charged with promoting and supporting the
involvement of people in the commissioning, provision and scrutiny of
local care services. LINks have the potential to serve as ‘learning plat-
forms’ by opening channels of communication between stakeholders
and key actors in healthcare networks. For example, they may obtain
views from people about health and social care needs and experiences,
convey those views to organizations responsible for commissioning,
providing and managing local health and social care services and make
reports and recommendations to those bodies on how services may be
improved.
As well as playing a major role in commissioning, LINks should be ide-
ally placed to monitor contract performance and service provision in a
rigorous and robust way by going out to groups and communities (DH
2006, para 2.7). The government’s aim is that they will form part of the
incentive structure encouraging commissioners and providers ‘to talk to
local people, to seek their views and insights, and to involve them in
how to plan, prioritise and decide their activities’ (para 2.9). The 2007
244 Organizational Innovation in Public Services

Act includes further incentives in the form of legal duties: (i) on Primary
Care Trusts (PCTs) and Strategic Health Authorities (SHAs) to report
on consultations before the making of commissioning decisions, and
on the influence that the results of consultation have had on those
decisions and (ii) on commissioners and providers to reflect upon and
explain what they have done differently in response to reports and
recommendations made by LINks. The effectiveness of these regula-
tory mechanisms in social learning terms will depend on how far they
succeed in encouraging proper reflection by the parties concerned, as
might be evidenced by the quality of the account and reasons they give
in explaining their decision. To date there has been little indication of
what will be expected of PCTs and SHAs in responding to consultation,
although the Department of Health will issue guidance in this regard
and LINks may choose to review the ways in which responses are made
(DH 2006, para 1.51).
Just as government may help facilitate such conditions of reflexive
governance, so its policies may inhibit their development. Policy confu-
sion and the privileging of economic over democratic elements in the
reform agenda are preventing the embedding of economic relations
in social relations (Krippner and Alvarez 2007; Polanyi 1957), which
is arguably essential in order for social learning effectively to occur in
healthcare networks (Vincent-Jones 2011). A major problem with NHS
modernization in England has been the simultaneous pursuit of voice
and choice initiatives that are in mutual tension and lacking in coher-
ent overall rationale (Vincent-Jones et al. 2009). Before the 2007 Act
was fully implemented, the government embarked on a further round
economic reforms in the Health and Social Care Act 2012, entailing
the abolition of LINks and PCTs and their replacement, respectively, by
Local Healthwatch and GP Commissioning Consortia. Inappropriate
or contradictory state interventions pose obstacles to the capacity of
key decision-makers such as those engaged in the commissioning and
provision of services, to resolve governance problems in the public
interest. This conclusion is consistent with studies highlighting prob-
lems of public contracting in other contexts such as the procurement
of public service infrastructure under the PFI (Treasury 2011). The con-
ditions of social learning must be established not only within public
service networks, but also at the level of policy-making and in public
administration. Experimentation at this level can only be legitimate
where it conforms to procedural and other requirements, including the
clear articulation of policy purposes, and provisions for monitoring and
evaluating success and for learning from failure (Vincent-Jones 2006;
Ladeur 2007).
Contractual Governance 245

Social learning and relational contract

The idea that contractualization might open up new spaces for social
learning in quasi-markets may be further explored with reference to
relational contract theory. Ian Macneil has analyzed the ways in which
all social exchange behavior is supported by the ‘common contract
norms’ of role integrity, reciprocity, implementation of planning, effec-
tuation of consent, flexibility, contractual solidarity, the protection of
reliance and expectation interests, the creation and restraint of power,
the propriety of means and harmonization within the social matrix
(Macneil 2000, 879–880). While discrete norms are particularly impor-
tant for planning, relational norms are necessary to support coopera-
tion throughout the duration of the contract.5 The term ‘relationality’
connotes an optimal configuration of discrete and relational norms
(both legal and extra-legal) in the contractual environment, enabling
the parties in private market transactions to govern and adjust their
ongoing relationships to mutual benefit (Campbell and Harris 1993).
It is important to note how this behavioral account differs from more
conventional legal approaches, which define contract in terms of the
enforceability of agreements at private law: ‘If we wish to understand
contract, and indeed if we wish to understand contract law, we must
think about exchange and such things first, and law second’ (Macneil
1980, 5). However, the point that the contract norms are not essen-
tially legal is not, of course, to deny the importance of this dimension.
Having stated that ‘law is not what contracts are all about’, Macneil goes
on to say that law remains ‘an integral part of virtually all contractual
relations’ (ibid. 5).6
Macneil’s relational theory may be considered in conjunction with
the social learning perspective introduced in the previous section.
The suggestion here is of a link between contract norms and behav-
ioral qualities of relationality, on the one hand, and the potential for
social learning in exchange relationships (including those that occur
in quasi-markets), on the other hand. Where exchange relations of
whatever kind are operating effectively, the common contract norms
are likely to be in robust condition and to be supported by additional
relational norms. This should enhance the capacities of the parties to
learn from one another and be receptive to external sources of informa-
tion. On the other hand, where contractual relations are in unhealthy
condition, and where the contract norms are revealed in ‘varying
degrees of disarray’ (Macneil 1983, 351), the social learning capacities
of the parties are likely to be reduced.7 The theoretical advance made by
linking the social learning and relational contract approaches lies in
246 Organizational Innovation in Public Services

helping to address the question of why relationality is such an impor-


tant feature of contractual governance, and how this quality may add
value in arrangements for the provision of public services. The answer,
it is suggested, has to do with the potential of contracts to serve in
the public interest as mechanisms for the promotion of social learn-
ing among all parties with interests or stakes in the services under
consideration.
In complex market exchanges, the efficiency gains associated with
relational contracting are dependent at least in part on social learning
processes that enable the parties to deal effectively with difficulties
and uncertainties that inevitably arise in the course of the transaction.
Relational contracts may facilitate innovation or may serve as mecha-
nisms of innovation. Similarly in the case of public contracting, we may
posit a correlation between relational contracting and social learning.
The crucial difference is that the success of governance arrangements
in this setting cannot be judged solely with reference to economic
exchange but requires consideration of the public nature of the func-
tions being performed, and the need to satisfy the interests of citizens
and service users on whose behalf contractual activities are undertaken.
In both settings, the majority of simple transactions may operate rela-
tionally without the need for any communicative interaction beyond
what is necessary to perform the contract. However, the more complex
the exchange, the greater the scope for social learning in negotiating
and managing the ongoing relationship.
This analysis points to a fundamental tension at the heart of contrac-
tualization. The state’s attempted use of the essentially private govern-
ance mechanism of contract to achieve public policy objectives appears
paradoxical. The joint-welfare maximizing properties of contract are
much more difficult to reproduce in programs of ‘positive policy-driven
regulation’ involving public contracting (Freedland 1998; Vincent-Jones
2006). A major concern is with how inappropriate central regulation
may damage the norms that support trust and cooperation in these
contractual relations, thereby limiting the scope for social learning.
The deleterious consequences of such intervention for contractual
relationships with private and voluntary sector bodies are evident in
many public sector studies (Reeves 2008; Deakin and Walsh 1996; Flynn
and Williams 1997; Van der Veen 2009; Davis 2007). For example, the
development of relational contracting in the English NHS has arguably
been hampered by continuous cycles of structural reform imposed by
central government. The attempt to introduce harder-edged contracting
through imposition of the ‘national standard contract’ in 2007 proved
Contractual Governance 247

particularly problematic (Hughes et al. 2011a). The failure of ‘complete’


planning was followed by a reversion to more relational styles, includ-
ing greater reliance on the NHS hierarchy, the avoidance of formal dis-
pute resolution and the adoption of risk reallocation compromises that
sometimes ignored contractual provisions (Hughes et al. 2011b). The
potential benefits of reflexive governance as social learning in quasi-
market organization may be difficult to realize in such a volatile and
unstable regulatory environment.

Governance by contract in the NHS

The introduction of the NHS internal market in 1991 marked a radical


break with the system of bureaucratic organization that had existed in
Britain since the 1950s. In place of annual budget allocations, fund-
ing was based on negotiated contracts for services between purchasing
health authorities and semi-autonomous NHS Trusts throughout Britain.
Since devolution, as noted earlier, the governments of Wales, Scotland
and Northern Ireland have adopted divergent policies for healthcare
reform.
England has implemented a range of initiatives designed to intensify
competition by: (i) encouraging an increasing diversity of private and
non-profit providers including specialist independent sector treatment
centres (ISTCs); (ii) establishing Foundation Trusts as independent
corporate entities with the capacity to enter legally enforceable con-
tracts, and to compete with independent sector providers; (iii) introduc-
ing standard tariffs to remunerate all providers in a system of ‘payment
by results’ (PbR); (iv) empowering patients to select among competing
service providers through the ‘choose and book’ system; and (v) creat-
ing arm’s length regulatory agencies responsible for overseeing com-
petition and maintaining standards among all state and independent
providers. Competitive incentives will be further strengthened by provi-
sions under the Health and Social Care Act 2012, which will enable the
outsourcing of clinical commissioning functions, and by supply-side
reforms designed to extend patient choice by opening up the market to
‘any qualified provider’ (DH 2011).
The NHS in Wales, by contrast, has remained closer to the original
vision of the internal market with limited competition and is moving
further in the direction of an integrated public service administered by
a reduced number of unified Health Boards. Contractual governance
has played a subsidiary role within what remains a centrally planned
system, with continued oversight by a government department and
248 Organizational Innovation in Public Services

restricted quasi-market development (no Foundation Trusts, no use of


standard tariffs, no independent treatment centers, relatively little inde-
pendent sector involvement, and non-enforceable contracts between
local health boards and conventional NHS Trust hospitals) (see Hughes
and Vincent-Jones 2008, 406). While the Labour/Plaid Cymru coalition
government has recently followed Scotland in abolishing the purchaser/
provider split in Wales, it has not honored its pledge to eliminate the
use of private hospitals by NHS purchasers by the end of 2011, due
mainly to rising waiting lists and pressures to make use of spare capacity
in the independent sector.
These differences between the NHS systems in England and Wales
offer promising subject matter for the comparative analysis of govern-
ance by contract. Building on existing studies undertaken from a rela-
tional contract perspective (Hughes et al. 2011b; Petsoulas et al. 2011),
the broad aim of further empirical research would be to investigate
how different norms, or constellations of norms, operate in ways that
are either conducive or inimical to social learning in the two systems.8
What sorts of social learning are made possible by, and may occur
within, the various horizontal and vertical relationships within the
different NHS structures? How do contractual and hierarchical relation-
ships differ in this regard across the systems? To what extent is the
capacity for social learning positively related to the specifically reciprocal
and consensual nature of a contractual exchange? How exactly does con-
tractual exchange open up spaces for social learning that may not be
present in other forms of coordination based on hierarchical direction?
How does the competitiveness of the environment in which contracts
are concluded affect capacities for social learning? How do contracts
that are legally binding differ from those that do not have this quality,
but which may still be considered contracts on Macneil’s behavioral
definition? To what extent might the techniques of ‘contracting for
innovation’ (Gilson et al. 2009) that are observable in private sector
transactions be applicable in the very different context of quasi-market
contracting for human services such as health and social care?
Against the background of different Patient and Public Involvement
(PPI) regimes and contrasting modes of regulation in the two systems,
the research might examine the interplay between the norms that guide
behavior and cognitive processes such as those involving double-loop
learning and frame-reflection (Argyris and Schön 1978). The key ques-
tion here is how far contractual and bureaucratic relationships differ
in their capacity for stimulating such learning. It has been suggested
that successful contractual relations (in social learning terms) are the
Contractual Governance 249

result of a productive tension between discrete and relational norms in


the contractual environment. A truly welfare-enhancing relationship,
therefore, is not one typically in which there are no problems or diffi-
culties, but rather in which such obstacles are recognized and overcome,
and opportunities for mutual benefit identified and exploited. While
integrated public services may offer certain advantages in fostering trust
and cooperation, the scope for innovation implicit in contractual proc-
esses may be lacking.
The research might further consider the implications for social learn-
ing of different types of norm enforcement (formal and informal pro-
cedures for sanctioning non-conformity or departure from patterns of
expected behavior) and explore the impact of litigation and the judicial
process in comparison with less formal mechanisms such as arbitration
and Alternative Dispute Resolution. Studies of private business con-
tracting have shown how collaborative relationships are routinely the
product of a combination of formal and informal, legal and non-legal
influences (Gilson et al. 2010; Hadfield and Bozovic 2012), and even
threats of litigation need not be antithetical to relational contracting
(Whitford 2013). In softer forms of quasi-market organization, internal
contracts are not legally enforceable because the parties lack separate
legal identities. While contractual governance may still operate under
such conditions, the abolition of the purchaser/provider split in Wales
is likely to result in the increasing displacement of contract by bureau-
cratic norms.
A further issue concerns the relationship between different ‘shades’ of
normativity, and the behavior which the norms reflect and to which they
apply; for example, the research might examine how the same norms are
applied or developed in varying private and public adjudicatory settings
in the NHS (mediation, arbitration, formal court processes), and investi-
gate the different effects on business communities and networks among
whom the results of norm enforcement are likely to be disseminated. It
might investigate how the mobilization and awareness of such norms
encourage the parties to reflect on their behavior, and to learn in order
to resolve problems and overcome blockages in their current understand-
ing, based on frame reflection and identity transformation (Lenoble and
Maesschalck 2010).

Conclusions

This chapter has explored the links between relational contract and social
learning in organizational arrangements for public service provision.
250 Organizational Innovation in Public Services

While the main focus has been on healthcare in England and Wales,
the perspective should be applicable to other services and be of rel-
evance to mixed governance regimes in developing and transitional
societies as well as in western liberal democracies. The selection of
healthcare as a case study is justified by the complexity of the issues
involved in the organization and governance of this particular human
service. Healthcare systems throughout the world face problems of ever-
increasing costs associated with an ageing demographic profile, rising
levels of chronic disease and increased expenditure on pharmaceuticals –
all in the context of the financial crisis and pressures to rein in public
expenditure. In the face of such challenges, what is required in order to
inform policy and decision-making is a robust set of tools for designing
and evaluating experiments in different modes of organization, based
on clear theoretical foundations.
We have suggested that public contracting in healthcare quasi-
markets opens up new spaces for social learning and organizational
innovation that may not exist in more traditional bureaucratic struc-
tures that rely on hierarchical ordering. However, the relative advan-
tages of bureaucratic and quasi-market organization in these terms
(and the specific benefits of the contract mechanism in the latter case)
remain unproven. The potential advantages of quasi-market contracting
may be outweighed by the negative effects of top-down reforms that
may undermine the relational conditions that are necessary for social
learning. There is also the danger of unresponsiveness in failing to pro-
vide adequate opportunities for public participation in the development
of policy and in decision-making on public-service issues. It should be
clear from the foregoing argument that social learning is by no means
guaranteed to take place through contractual processes and that the
conditions of reflexive governance may be achieved just as effectively
by the reform of public bureaucracies and by other forms of stakeholder
engagement.
If the driving force behind contractualization in England has been the
pursuit by central government of a policy agenda of increasing privati-
zation and commercialization of public services, it is hardly surprising
that the political preference for more traditional, unified forms of public
service delivery in the devolved governments of Scotland and Wales has
resulted in a declining emphasis on governance by contract. However,
while bureaucratic integration may help resolve tensions between the
choice and voice elements in the NHS reform agenda, the problem of
how to increase patient and the public involvement in the governance
of healthcare remains. The abolition of the purchaser-provider split
Contractual Governance 251

removes the potential for social learning through the contract mecha-
nism, while limiting the scope for innovation associated with competi-
tion and diversity of provision. Further empirical research is needed in
order to determine what type of public service organization provides
the best environment for social learning and reflexive governance in
the public interest.

Notes
1. Similarly in the United States, contract was regarded from the 1950s as an
instrument of regulation and a means of social control (Miller 1955). The
associated breakdown of the private/public distinction was marked by a trend
toward discharging governmental responsibilities by the sharing of govern-
mental power with independent entities (Miller 1961, 967; Langrod 1955;
Freeman 2000).
2. Recent policy initiatives include the outsourcing of prison and policing
services such as the investigation of crime and detention of suspects; the
contracting out of employment services to private companies remunerated
according to their success in finding work for jobseekers; and the transfer of
ownership of roads and transport infrastructure from the Highways Agency
to the private sector. Through the contract mechanism responsibilities for the
provision of public services are shared with an increasing range of private and
non-profit entities in sectors such as environmental management, health and
social care, welfare and social security, employment and training and policing
and criminal justice.
3. For a more detailed exposition of the theoretical perspective, including discus-
sion of a fourth (‘genetic’) set of conditions of social learning in the health-
care context, see Vincent-Jones and Mullen (2010). Lenoble and Maesschalck
(2010) consider that fully reflexive governance is not possible without such a
genetic dimension, incorporating all the other dimensions.
4. See Burris et al. (2005): ‘A node as we conceive of it is a site within an OGS
(Outcome Generating System) where knowledge, capacity and resources
are mobilized to manage a course of events’. The node as a site governance
comprises four essential characteristics: a way of thinking (mentalities); a set
of methods (technologies); resources to support the node’s operation; and
institutions that structure the mobilization of mentalities, resources and tech-
nologies over time’ (12). ‘Superstructural nodes are the command centres of
networked governance’ (13).
5. The exercise of choice through planning requires both ‘discreteness’ (‘the
separating of a transaction from all else between the participants at the same
time and before and after’) and ‘presentation’ (‘the bringing of the future into
the present’) – Macneil 1980, 60.
6. While the debate as to how far the law of contract should promote relation-
ality is of secondary importance in the present analysis, the social learning
approach must remain sensitive to the possible effects of different types of
norm (both non-legal and legal) on problem solving and decision making
in contractual relationships. Such differences are likely to be particularly
252 Organizational Innovation in Public Services

important when comparing justiciable and non-justiciable contracts in ‘hard’


and ‘soft’ quasi-markets for healthcare in countries within the UK.
7. Contractual relations in this condition will be characterised by disproportion-
ate intensification of the planning and consent norms that serve to enhance
discreteness and presentiation: ‘a sufficiently serious defect in any one of the
contract norms will bring a contractual relation down over time’ (Macneil
1980, 168).
8. The research design might draw on the existing literature in marketing and
management studies which seeks to operationalize Macneil’s contract norms
in the empirical study of ‘business to business’ transactions – see Blois (2002);
Gundlach and Achrol (1993); Heide and John (1992); Kaufman and Stern
(1988); Lusch and Brown (1996); Pilling et al. (1994). For a critique of the use
of scales derived from the contract norms to quantify the degree of relational-
ity in such studies, see Blois and Ivens (2006).

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