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Wednesday, April 21, 2010

Economics of scale vs economics of competition

Public procurement has at least two means to achieving the goal of maximizing bang for buck.

One is to buy in bulk, under the theory that the more units that can be purchased from a single supplier, the greater will be the discount for the total cost. That's sort of the buy wholesale, not retail concept.

This tends to favor suppliers who dominate a market by shear size. For instance, not many Mom & Pop stores can compete against a WalMart. It also tends to entrench reliance on a particular supplier. This approach supports purely economic considerations of government purchasing (assuming no political favourtism).

The other is to promote competition by spreading around the purchase orders. The theory here is that the more competitors there are, the more likely it will be that the price will more closely approach the cost of production.

This tends to put a heavy load on procurement staff to develop competition and to administer more solicitations and contracts. This approach tends to support other socio-economic considerations applicable to government purchasing (discounting political pandering by passing around government largess) in addition to the competition theories of economics.

The tensions and contradictions between these two approaches is perhaps illustrated in the following two articles from the same journal.

Poor procurement "has wasted £25bn"

The public sector is squandering at least £25bn a year through badly organised procurement and outsourcing, according to a report by the Institute of Directors (IoD).

'Radical restructuring' of procurement could save £15bn and more use of shared services and outsourcing could save £10bn, the IoD claimed – and the savings could be delivered within three years.

the majority of public procurement spending is so fragmented that huge potential savings are being missed every year. This is because most of the public sector still organises itself on the "corner shop" model, the IoD said, with the majority of purchasing organised in small scale silos. In other words, local authorities, NHS trusts and small central government departments all do their own thing.

The result is massive duplication and a constant reinvention of the wheel, which could be avoided if with legal services, IT, human resources and other services were sourced centrally. Instead of integrating their buying and outsourcing, hundreds of public sector organisations are each "wading through a morass of contract terms and conditions, procedures, processes and interpretations of procurement law", the report said, adding that if multinational companies operated like the public sector, they would have gone out of business years ago.

The solution is simple – integrated public sector procurement and outsourcing, ie centralised buying organisations that handle all key supplier relationships and all national and major contracts on behalf of the whole public sector. Local needs could be met by regional procurement hubs to provide expert contracting support to all organisations within the area. And all public sector bodies would have to use this system.

'Old boys network' in procurement
An Indian outsourcing company has accused the government of having an "old boys network" when it comes to IT procurement, often meaning it is not getting the best price.

In an interview with the Financial Times, Vineet Nayar, chief executive of HCL Technologies, said there was currently a "stranglehold" of a few companies on public sector technology procurement.

He believed his company could run IT services for the public sector at about 20 per cent less. But he said many UK authorities were unwilling to shortlist HCL because of their strong relationship with existing suppliers.

The FT has also quoted a number of experts in the field, admitting that the UK IT sector is one of the "most concentrated in history".

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