CHAPTER 3
MANAGING COMMONWEALTH IT OUTSOURCING
The Approach to Outsourcing
The committee is concerned that the timing and process of outsourcing
appear to be driven principally by the anticipated opportunity for cost
savings over the current budget cycle. The 1997-98 Commonwealth Budget
locked in savings from IT services over the next four financial years.
As Budget Paper No. 2 made clear, 'the government is seeking long-term
improvements in the structuring and sourcing of IT services across agencies,
with the aim of facilitating greater integration in the delivery of programs
and realising significant cost savings [emphasis added]'.[1]
Efficiencies are to be obtained by consolidating IBM and compatible data
centres and by outsourcing IT infrastructure services, following competitive
tendering. Savings of $38.1 million dollars are to be achieved in budget
year 1998-99, $89.5 million in 1999-2000, and $103.5 million in 2000-2001.
As the head of OGIT testified, 'if the savings are not achieved, they
are taken out of the department's operating budget'.
Although the government considers the savings to be 'conservative and
achievable', little consideration seems to have been given to the reservations
expressed in the agency coordination comments to the Cabinet submission.
There is considerable debate about the real extent of savings available
to individual agencies when proper consideration is given to their particular
functions and the efficiency of their existing IT services. It appears
that insufficient weight has been given to the overall Australian Public
Service environment in which the change to outsourcing is being pushed,
to the variety of IT services required by Commonwealth agencies and to
the factors which, on the basis of reported experience elsewhere, may
reduce or eliminate savings and/or reduce the quality of service provided.
Many Commonwealth agencies believe that costs of outsourcing, particularly
the redundancy or other transition costs for staff, cannot be estimated
accurately at this stage. The changes to employment transition and superannuation
conditions since the budget would tend to support this. The comments to
the Cabinet submission suggest that costs to agencies of managing the
actual process have not been allowed for in the savings calculations.
Savings Estimates
The general unwillingness of officials or the Assistant Treasurer to
discuss the detail of costings or provide the business plan on which they
were based limits the committee's ability to discuss this issue. Budget
Paper No. 2, 1997-98, sets out a table of the proposed savings for the
next three financial years. It notes that, 'savings are based on estimates
of the minimum savings agencies could be expected to achieve through consolidation
and outsourcing ... net of employment transition costs'.[2]
The savings estimates are approximately the same as those included in
the cabinet submission. In the absence of public discussion of the costings
by government the coordination comments on that submission are the only
source which the committee can draw on in assessing the validity of the
savings estimates. The comments are critical of the level, derivation
and mandating of those savings.
Treasury expressed concern at the method used to arrive at savings 'particularly
for non-mainframe departments'. Like many other agencies it argued that
'by using an average benchmark against which to estimate individual savings,
the Submission ... favours organisations with excessively large or inefficiently
operating systems'.[3] The Australian
Taxation Office (ATO) has expressed concerns that the time frame of the
proposal would present major difficulties but that it 'recognises the
Budget imperatives that underpin the Submission'[4]
and will therefore seek to deliver the savings required.
The Department of Defence commented that, with regard to Defence desktop/network
costs:
it is not clear how OGIT determined the extent of such costs within Defence
or which Defence systems and infrastructure has been judged to be included
in that category. The basis for the identified savings from Defence is,
therefore, neither clear nor agreed.[5]
The Department of Health and Family Services (DHFS) expressed concern
`about the dubious derivation and level of the savings'. DHFS concluded
that `the savings are overstated by more than 30%'. The Department was
particularly concerned that the studies on which the costings were based
showed a range of costs for workstations from $3 000 to $10 000 yet a
uniform saving was applied to all agencies which `penalises the efficient'.
DHFS also stated that its mainframe costs had been subject to an OGIT-sponsored,
independently conducted, benchmarking exercise which places them ahead
of world's best practice.[6]
The Health Insurance Commission (HIC) described the savings assumptions
applied to it as arbitrary and unreliable. The HIC has been subject to
a benchmarking study conducted by OGIT which showed that it was already
50 per cent more efficient than the Commonwealth average. The Department
of Social Security concluded that DSS and the HIC `have shown mainframe
costs which don't suit the argument in that they are too low and therefore
average costs of other agencies are used instead'.[7]
The Department of Immigration and Multicultural Affairs also commented
on the unreliability of indicative costs from vendors, noting that its
experience `suggests that these indicative costings will increase significantly
once the detail is worked through'.[8]
The ATO noted that it,
has serious misgivings about the level of savings identified for its
operation ... Since 1993 the ATO has been involved in two Mainframe Benchmarking
exercises. As a result, it believes that it has a good appreciation of
its mainframe running costs ... mainframe savings in the order of a further
30%-35% for the delivery of the same services are difficult to envisage.[9]
The ATO warned ministers that the savings estimates were no more than
'best guesses after limited inquiry'.
DSS expressed concern that the savings target imposed on it,
totally ignores the possibility that these two agencies [DSS and the
Health Insurance Commission (HIC)] because of their size and their focus
on efficiency may be much closer to "best practice" than many
other organisations.[10]
The coordination comments also reflect concern that the policy fails
to acknowledge that agencies are at very different stages of development
with their IT services. Both the timing and potential for savings may
be influenced by this to a significant degree. The Department of Primary
Industries and Energy (DPIE) noted that 'the proposed savings [do] not
take into account those savings which the Department will achieve through
currently planned standardisation and consolidation'.[11]
The Transport and Regional Development Department expressed similar concerns
and concluded that 'whilst there might be overall savings of 15% ... it
would be incorrect to accept the OGIT assumption that all agencies could
achieve an equal saving of 15%'.[12]
Clusters
The distinctive feature of the government's outsourcing policy is the
clustering of major agencies into groups having large IT requirements.
The clusters are intended to facilitate the garnering of economies of
scale and to reduce the diversity of systems operating throughout Commonwealth
agencies. Clusters were assembled having regard to the common features
of the agencies included in them and a data processing capacity of approximately
400 MIPS as a guide to the size of each cluster. There was considerable
discussion before the legislation committee about the appropriateness
of MIPS as a guide to the formation of clusters. It is clear that the
measure was no more than indicative and was not applied rigidly. Perhaps
more significantly it should be noted that the South Australian government's
outsourcing of its IT requirement in one contract represented approximately
200 MIPS of capacity. Thus the cluster contracts envisaged by the Commonwealth
are extremely large by Australian standards. This has a number of implications.
The impact on industry is discussed in Chapter 5.
The comments of the Australian Bureau of Statistics (ABS) summarised
other concerns:
The degree of standardisation expected to result from the clustering
strategy will also stifle rather than encourage the very innovation essential
to the re-engineering of the delivery of government services. This is
worrying in that the government's requirements for IT services have changed
rapidly and substantially in the past few years as have the composition
and structure of departments.[13]
The view that consolidating requirements in pursuit of economies of scale
may not be the best way to proceed was supported by a number of witnesses
to the committee's inquiry. For example Ian Dennis, representing the Australian
Computer Society agreed that,
There are economies of scale that can be achieved by bringing together
like processes ... while you are working in a mainframe environment, it
might be a very good way to do things. If you move away from a mainframe
environment, some of those economic arguments change.[14]
He further suggested that 'the economies of scale of consolidation are
very fast being overcome by the economies of process of disagregation'.
This point that different approaches may be desirable for the various
types of IT environments - mainframe, mid-range and desk-top - was echoed
in agency comments. DPIE, a medium-sized department where 80 per cent
of IT costs relate to desktop infrastructure, noted that 'the conclusions
drawn ... from the scoping studies in regard to medium sized agencies
cannot be reliably extrapolated and ... the clustering of these sites
and their outsourcing should not be mandated' and queried whether 'the
anticipated savings can actually be realised by outsourcing a combined
mid-range and desktop infrastructure'.[15]
The potential for clusters either to limit the freedom of government
to make machinery of government changes or to impose costs on government
where it proceeds with changes has been amply demonstrated by the history
of Cluster 3. Since the clusters were announced Cluster 3 has lost the
Australian Securities Commission as a result of changes to financial regulation
structure in the wake of the Wallis inquiry and the Department of Administrative
Services which was abolished in early October shortly after the draft
request for tender for cluster three was distributed. The bulk of DAS
functions have been absorbed by the Department of Finance. Some of the
IT requirements of the former DAS will remain in Cluster 3 while the rest
will go with the Department of Finance and will be included in Finance's
outsourcing via the controversial 'piggyback' decision on DVA's contract.
It is estimated that the withdrawal of the ASC and DAS has reduced Cluster
3's aggregate requirements by about 40 per cent. Apart from disrupting
the clustering arrangement and the tender for Cluster 3, this demonstrates
the potential for problems should future machinery of government changes
cut across existing IT contracts.
Failure to Acknowledge the Risks Involved
In his remarks to this committee at its hearing on 4 July 1997 the head
of OGIT, Dr Macdonald, while acknowledging that IT outsourcing required
great care if it was to yield the desired results, seemed rather complacent
in the belief that the Commonwealth would succeed where others had not.[16]
Studies of outsourcings that had failed to meet their objectives were
dismissed as reflecting the relative inexperience of the early days of
contracting out or as little more than useful additions to the body of
knowledge of the subject.
The coordination comments on the Cabinet submission are a useful antidote
to that view. Agencies commented on the failure of the submission to present
ministers with a balanced appreciation of the degree of risk involved
and the alternative means by which savings could be achieved while avoiding
most of the risks and disruption inherent in the proposal. The Australian
Taxation Office (ATO) noted that the submission had failed to address
the risks involved in the proposal and commented that,
The submission should ... inform Ministers that world wide experience
with outsourcing demonstrates mixed success. [It] gives no assurances
that the Commonwealth is better positioned to ensure more successful outcomes,
particularly having regard to the very short timeframes envisaged.[17]
The ATO, along with a number of other agencies, commented that the range
of services to be outsourced and the adoption of a whole of government
approach extended the uncertainty as to the outcomes. Treasury noted that
'Outsourcing poses major business and management risks without, in all
cases, certain financial gains'. The Department of Social Security argued
that the savings envisaged 'are actually very small in the totality of
government spending' yet the submission failed to advise Ministers that:
the scale of outsourcing proposed here is unprecedented and that there
are numerous studies of less adventurous outsourcing exercises with very
low success rates. These studies show that if we can achieve "best
practice" in outsourcing we may still have a 50% failure rate.[18]
The consequences of failure extend far beyond simple failure to meet
savings targets and include significant losses and breakdown of programs.
Managing the Process
Many agencies noted that while OGIT acknowledges the shortage of personnel
within the APS who are `skilled in the development of outsourcing tenders
and contracts' and in contract management, no provision was made for agencies
to acquire those skills even though the cabinet submission specifies that
considerable agency resources will be required. OGIT itself is to receive
$13m. A number of agencies expressed concern with the apparent requirement
that they rely on OGIT for these skills. The Department of Transport and
Regional Development noted that,
considerable agency resources will need to be deployed to the outsourcing
process yet the savings target does not recognise the cost for Agency
[sic] to acquire or train staff with those necessary skills.[19]
The Australian Customs Service commented in similar terms and proposed
that 'consideration should be given to netting all such identified costs
from the proposed savings on an agency by agency basis'.[20]
The then Department of Industrial Relations (DIR) warned 'that the management
task and the resources ... required by agencies ... should not be underestimated,
in particular the human resource management task' and expressed two areas
of particular concern. OGIT's role in developing a human resource framework
'would arguably overlap with existing central agency responsibilities'
and had the potential to produce inconsistency of information and policy
advice. Secondly DIR shared the concern that OGIT was the only agency
receiving funding to support implementation and warned that the development
of an efficient working relationship between OGIT and other agencies was
critical to the success of the policy.
The Department of Social Security has described as `dictatorial' [the
government's] `approach in terms of process and timing [which] runs a
very real risk of giving perverse results'. DSS noted that,
OGIT/DoF are made responsible for savings and will assess their own performance.
Agencies will have to deliver savings without regard to the impact on
total outlays. This is not consistent with best practice.[21]
DHFS commented on the imposition of `a very top heavy central agency
focussed administrative structure on the market testing process which
will increase the costs to agencies'.[22]
The former Department of Administrative Services (DAS) developed very
considerable expertise in the area of IT acquisition which has been used
by many agencies over many years. It appears that this expertise is being
marginalised.
The Department of Immigration and Multicultural Affairs queried why,
a centralised approach would need to be taken when the risk has been
specified to remain with individual agencies and at a time when the Government's
workplace relations reforms are encouraging agencies to pursue approaches
which best suit their operational requirements.[23]
The public service reforms embodied in the new public service legislation
also emphasise the autonomy of agency heads. The 1991 Department of Finance
circular stressed that 'agency heads retain overall responsibility for
IT procurement' and the importance of retaining 'overall control of their
IT strategy including the activity being outsourced'. To continue to discharge
responsibility for IT strategy effectively agencies will still require
high level in-house expertise. This will be made more difficult if a central
agency focus emerges. In addition, in a highly competitive market characterised
by a number of major private sector companies delivering IT services to
government there will be limited opportunities within the public sector
for high quality IT managers. Agencies may experience difficulty in retaining
the standard of in-house skills they require both for IT policy development
and contract management, given the significant remuneration difference
between the two sectors.
Tendering
Both taxpayers and potential contractors must have confidence in the
probity of the tendering and contracting process. The decision of the
Department of Finance to 'piggyback' on the DVA contract was not an auspicious
start particularly after the recent augmentation of Finance with parts
of the Department of Administrative Services. It is clear that unsuccessful
tenderers for the DVA contract felt that the Finance decision was undesirable.
The committee is concerned that the decision to piggyback appeared to
have been initiated by the contractor and had not previously occurred
to the department involved. At the time that the decision was contemplated
it is arguable that it was in breach at least of the spirit of the then
current Commonwealth Procurement Guidelines. Guideline 2(7) stated that:
Open and effective competition requires that as far as practicable requirements
be openly advertised and contracts competitively arranged. It is inconsistent
with this concept for a department to access ... contracts not arranged
for its use...
The committee notes that no further piggybacking arrangements are to
be entered into at present. The committee is of the opinion that where
future contracts provide the option for third parties to join the contract,
that option must be made explicit in the request for tender and the contract.
In-house Bids
Where an agency decides to market test a service it may put together
a team from within its own staff to develop a bid for that service in
competition with external vendors. The Defence Department undertook such
a process as part of the process of putting its IT services out to tender.
The success of the Defence in-house team in winning the contract to provide
IT services has given encouragement to those who support the use of in-house
bids more widely as part of the whole of government approach to outsourcing.
Many commentators and agencies see considerable value in in-house bids.
Whether successful or not an in-house bid gives an agency a high degree
of certainty about the cost estimates for its own services and provides
a valuable benchmark against which to assess the other external tenderers.
Where successful an in-house bid can avoid many of the problems which
can occur with an external contract. Transition to the contractor, continuity
of service provision, maintenance of employment conditions, privacy and
public accountability can all be simplified. It has also been suggested
that an in-house team will offer a better prospect of achieving the close
working relationship between the agency and its IT service provider which
commentators consider essential to the success of a contract.
It is important that, where an in-house bid is contemplated, the agency
structures the process to ensure its probity. The in-house bid team must
be completely separate from the agency's IT service and play no part in
defining, costing or managing the market testing process. The in-house
team must not receive any unacknowledged operational subsidy from within
the agency so that its costings are directly comparable to those of other
tenderers.
The private sector, through the Australian Information Industry Association
(AIIA), has made it clear that it is 'fundamentally opposed' to in-house
bids. AIIA believes that it is extremely difficult to ensure competitive
neutrality in the tendering process where an in-house bidder is involved.
The Association also believes that, where successful, such a bid denies
the agency access to the benefits of risk sharing and partnering which
it claims are benefits of outsourcing.
A number of witnesses pointed out that because a successful in-house
bidder is also an agency of the Commonwealth the relationship between
the agency and the in-house bidder cannot be governed by contract. This
may be a source of weakness if problems arise in the business relationship.
Mr Boucher of the Attorney-General's Department, however, indicated that
there was little practical difference between a memorandum of understanding
(MOU) between two arms of government and a legal contract between an external
party and the Commonwealth. While he acknowledged that as a matter of
law, the Commonwealth cannot sue the Commonwealth, he believed both contracts
and MOUs could contain a suitable range of protections from service failures,
including cost and commercial penalties.[24]
The government has supported in-house bids in principle but little practical
encouragement is given to organising such bids. In reality, the use of
clustering will create very large contracts which are beyond the scope
of an in-house bid team. The opportunity for an in-house team to take
up sub-contracts will also be limited. The committee notes that the RFT
for Cluster 3 specifically excludes in-house bids.
Consultation
The Department of Foreign Affairs and Trade expressed concern that, while
OGIT had consulted with agencies, few of their concerns were reflected
in the Cabinet submission. DSS commented that,
"Consultation" has occurred only in relation to obtaining agency
costs. There has not been any sharing of information from submissions
of potential outsourcers so agencies have no basis to assess the relevance
of the recommendations ...[25]
The various comments from agencies made in the Cabinet submission quoted
throughout this chapter, which go to the circumstances of individual agencies
and their probable impact on the process, lend support to the view that
consultation between the Department of Finance and OGIT and other agencies
was inadequate in the development of the policy.
At its hearing of 4 July 1997 the committee raised the issue of the relationship
between OGIT and other Commonwealth agencies. Agencies saw OGIT's role
as 'a facilitator, a consultant and a coordinator'.[26]
Generally agencies were satisfied with the work OGIT had done in those
roles and reported constructive working relationships with OGIT. Mr Highfield,
Second Commissioner with the Australian Taxation Office, noted that OGIT
had a difficult role in promoting a cultural change in the public sector:
It is my observation that there is a very strong culture of agencies
effectively doing their own thing over many years. I see it as very central
to the role of an agency like OGIT to foster whole of government approaches.
... in the short number of years that it has operated , it [has] made
achievements on that particular front ...[27]
Some of the difficulties in communication noted in the comments on the
Cabinet submission clearly reflect an early stage in the development of
the approach to outsourcing. In areas such as employment transition and
industry development subsequent announcements of government policy have
addressed comments from other agencies and clarified these issues.
Conclusion
The government's stated objective for Commonwealth use of IT is 'to achieve
a more efficient use of IT infrastructure and cost savings [are] an important
component'.[28] Outsourcing the
provision of IT services to private sector providers should be only one
option for achieving that objective. Agencies should have the genuine
choice of rejecting outsourcing if, after proper consideration, they decide
that alternative approaches to managing their IT offer a better balance
of efficiency gains, cost savings, service improvement and the various
public policy concerns to which they must have regard.
It appears that there is a risk that IT outsourcing will become an end
in itself. This is demonstrated by the locking-in of savings in forward
estimates (which must be achieved irrespective of the actual savings in
the IT area), the budget-driven action of the former Department of Finance
in seeking to 'piggyback' on the outsourcing contract of the Department
of Veterans' Affairs and the discouragement of in-house bidding for IT
services.
The committee considers that the successful provision of IT services
is at risk as a result of the centralised approach being adopted, the
imposition of the clustering, mandated savings imposing pressure on agencies
to give priority to cost cutting and time constraints. The Government's
position, as put to the legislation committee, seems illogical. Mr Maclean,
representing OGIT, told the committee, 'we are not asking [agencies] to
outsource; we are asking them to test the market to see whether their
[IT services] can be more effectively delivered from outside'.[29]
Why then have projected savings been locked into the Budget irrespective
of the outcome of the market testing process? Agencies whose IT costs
are competitive with best practice or who for other reasons are faced
with unrealistic savings targets will have to deliver up the mandated
savings from other parts of their operations. There appear to be good
grounds for believing that the actual savings targets are flawed and that
to demand savings from agencies irrespective of the IT market testing
outcome is little more than a poorly disguised budget cut. The mandated
flat rate savings also risk producing perverse outcomes whereby efficient
agencies with a firm grip on their IT costs will be penalised. In the
light of agency comments the government should re-examine the proposed
savings strategy.
The use of clusters has been criticised as being likely to stifle innovation
and inhibit government's ability to respond to the rapidly changing IT
environment. It is also suggested that the use of a small number of large
contracts will restrict the freedom of governments wishing to make machinery
of government changes during the life of a contract. Governments may be
faced with cost penalties or disruption to services if they make such
changes.
Savings are mandated to commence in financial year 1998/99 for some agencies
and for the majority of agencies in the following financial year. This
would appear to allow agencies ample time. However, as the committee has
indicated elsewhere in this report, successful market testing and contracting
out undertaken by the Defence and Veterans' Affairs Departments actually
took a significant number of years to come to fruition. With the added
complications of the whole of government approach, the use of clusters
and the range of services to be outsourced, the committee is concerned
that agencies may be given inadequate time to get the process right.
The committee favours a more 'agency driven' approach which would also
be consistent with the government's general objective of devolving responsibility
for management away from central agencies to agency heads.
All agencies have been subject to efficiency dividends for a number of
years from which IT has not been immune and to the requirements of the
1991 Finance direction with regard to market testing. The evidence of
the coordination comments to the Cabinet submission suggests that agencies
have all been pursuing efficiencies within their IT areas for some time.
It may be more efficient for agencies to provide for their IT service
via a number of different contracts which may or may not involving clustering.
Such an approach would not preclude voluntary clustering or the adoption
of whole of government initiatives.
There is a certain irony in the fact that the two successful models of
IT outsourcing in the Commonwealth, the Departments of Veterans' Affairs
and Defence undertook their outsourcings in ways that were different from
each other and quite distinct from the current Commonwealth approach.
Footnotes:
[1] Budget Paper No. 2, 1997-98,
Canberra 1997, p. 161.
[2] Budget Paper No 2, 1997-98,
Canberra 1997, pp. 160-61.
[3] Cabsub, Attachment B, para
19.
[4] ibid., para 39.
[5] ibid., para 101.
[6] ibid., paras 110-115.
[7] Cabsub, Attachment B, para
105.
[8] ibid., para 107.
[9] ibid., paras 40-41.
[10] ibid., para 105(f).
[11] ibid, para 70(c).
[12] ibid, para 99(e).
[13] Cabsub, Attachment B, para.
8.
[14] Committee Hansard,
4 July 1997, p. F&PA 652.
[15] Cabsub, para70
(b).
[16] Committee Hansard,
4 July 1997, pp. F&PA 497-500.
[17] Cabsub, Attachment B, para
36.
[18] ibid., para 105.
[19] ibid., para 99 (c)
[20] ibid, para 6.
[21] Cabsub, Attachment B, para
105.
[22] ibid, para 115.
[23] ibid., para 109.
[24] Committee Hansard, 16
May 1997, pp. F&PA 196-7.
[25] Cabsub, Attachment B, para
105 (c)
[26] Committee Hansard,
4 July 1997, p. F&PA 521.
[27] ibid.
[28] Dr A Macdonald, Chief Government
Information Officer, Committee Hansard, 4 July 1997, p. 501.
[29] Finance and Public Administration
Legislation Committee Hansard, 8 May 1997, p. 75.
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