Introduction The 12 Guiding Principles in Using Market Testing and Contracting Out describe the Government's policy on using efficiency reviews and competition in modernising Government services. This Guidance is for senior managers. The companion Handbook describes the policy and key processes for project managers and bidders, but is also relevant to senior managers. References to "Departments" include their Agencies and NDPBs.   Permanent Secretaries, and Chief Executives should ensure that the 12 Guiding Principles are applied. The Government's objectives 2. The Government's objective is Better Government, which includes value for money in Government services. Value for money means better quality services at optimal cost. The Government is working with the private sector to achieve this through Public Private Partnerships. Competition – market testing and contracting out (or the Private Finance Initiative) – should be used when, case by case, it can be shown to offer better value for money than other means. 3. Competition is not the only option. If there is a continuing need for a service or activity, benchmarking and restructuring may be more appropriate in the circumstances. These can also be Public Private Partnerships. (There will be separate guidance on benchmarking and restructuring.)   Public Private Partnerships include Private Finance Initiative (PFI) (1)deals, contracts with the private sector following contracting out or market testing ("outsourcing"), joint ventures, benchmarking, linkages, and other collaborations between the public and private sectors to bring about better quality services at optimal cost. 4. Better quality at optimal cost should be pursued strategically: within a Department – looking at the Department's long-term objectives and relationships to other services; and across Departments – looking at the Government's objectives as a whole and, where appropriate, seeking complementary value for money with other Departments. 5. Departments should also take account of the Government's wider objectives, for example on sustainable development and fair employment.   12 GUIDING PRINCIPLES IN USING MARKET TESTING AND CONTRACTING OUT issued by the Chancellor of the Duchy of Lancaster, 1997 (2) 1. Our aim is to develop modernised, high quality, efficient, responsive, customer-focused central Government services. Our approach to this is pragmatic not dogmatic. 2. We will work in partnership with the private sector, extending the circle of those involved in public service. 3. We will use market testing and contracting out when in individual cases these can be shown to offer better value for money, that is: better quality services at optimal cost. Our approach to this is pragmatic not dogmatic. 4. Existing plans for market tests and contracting out, therefore, should proceed, unless the Minister is satisfied that in the circumstances of an individual case, better value for money can be achieved by other means, which will enable a Department to live within its running costs ceilings. This judgement should be based on a robust and objective comparison of the particular market test or contracting out exercise and the alternative means available. 5. Ministers remain accountable for services contracted out to the private sector. (That is the Carltona principle is replicated.) 6. The energy, skill and commitment of staff are our best assets in modernising public services. They should be properly trained to carry out market testing, contracting out, benchmarking, restructuring and other means for achieving better value for money that is: better quality services at optimal cost. 7. The concerns of those affected by change should be fully taken into account and properly addressed. 8. Where the relevant circumstances apply when work transfers, staff will be protected by the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) and the consultation and information requirements of those regulations should be followed scrupulously. To avoid a successful claim for constructive unfair dismissal when staff transfer from Crown employment in circumstances to which TUPE applies, Departments should ensure that the new employers offer broadly comparable occupational pension provision or suitable compensation. 9. Full, effective and continuous communication is a key to successful improvement and change. It should begin as soon as a review which might lead to change is mooted and it should continue afterwards to share what has been achieved. It should happen even when there may be little to report. That way, staff, and their recognised trade union representatives, can be engaged throughout and rumours can be avoided. 10. There should also be full and open information and communication with Departments' customers and stakeholders. 11. Relations with the private sector need to rest on two-way openness and trust. Until the Government's new arrangements on freedom of information are in place, Departments should apply a liberal interpretation to the existing Code of Practice on Access to Government Information and its Guidance on Interpretation. Unsuccessful bidders need to know why they were unsuccessful and how they could succeed next time. For the public, it is important to know how much central Government services cost, no matter who provides them. Commercial confidentiality must not be used as a cloak to deny the public's right to know. 12. Senior management in Departments must give leadership in all these areas and should encourage innovation and continuous improvement.   What needs to be done 6.Departments should routinely review their services and activities, decide how best to improve value for money in the circumstances and carry out the improvement programme. The key stages are: review services and activities; set performance standards; appraise the options; scoping and feasibility; competition; contract management; evaluation; and retendering. 7.Review services and activities to decide what action is required. Such reviews should be regular and systematic. Over a period of five years all of a Department's activities should be reviewed. Requirements should be expressed as outcomes and outputs not as functions or processes. New requirements should also be expressed as outcomes and outputs.     outcomes – what is to be achieved strategically outputs – what is to be produced or delivered   8.Set performance standards. These should cover cost and quality (3). They should be challenging and reflect the views and needs of customers/users and the results of research into what could be achieved, for example, by benchmarking (4). Performance standards should be set so that options can be appraised. They should be reviewed continuously during efficiency reviews and competitions, and they should always be challenging, so that better quality at optimal cost can be achieved. 9.Options. Make or buy: the key question is whether to make/improve what is required or whether to buy the service, so long as it is needed and the Government has to be responsible for it.   Options Abolish if the service is no longer needed. Restructure internally after bench-marking has been used to diagnose where improvement is needed. Restructuring might be within the existing framework of the service or activity or by merger with another part of the Department, or by merger with a similar service or activity in another Department. Strategically contract out buying the service from the private sector after a competition between external bidders only. Benchmarked against the costs arrived at in the option appraisal. Market test – a competition with an in-house team bidding against external (usually private sector) bidders. If an external bidder is chosen, the result is referred to as "contracting out" or "outsourcing"; and staff and expertise will transfer (unless TUPE does not apply – see paragraphs 24–30, below). Privatise if the Government need not be responsible or could achieve its objectives by regulation. Staff and expertise will transfer to the successful bidder (unless TUPE does not apply – see paragraphs 24–30, below). (These are the same options that are used in reviewing Next Steps Agencies and NDPBs.) There should be no hierarchy or implied preference in considering these options. The Government's approach is pragmatic, not dogmatic. The question is which will best deliver value for money in the particular circumstances? The costs and likely quality outcomes of the options should be appraised, in accordance with HM Treasury's "Green Book" (5). There should be a comparison of: existing costs; projected costs after the efficiency exercise (for new services, there should be a comparator derived from benchmarking to help ensure that value for money will be achieved); and the costs of carrying out each option – that is, the process costs. The higher the process costs, the less optimal will be the value for money delivered. As good practice (6), Departments should chose the option that will:   avoid compromising value for money in the future;   best develop human capital, in all the circumstances;   in the long term, best assure innovation and continuous improvement;   offer the best balance between savings and quality improvements at the lowest cost of achieving it;   best avoid prolonged and corrosive uncertainty for staff and external bidders. Unless the option appraisal suggests an in-house bid is very likely to succeed, it may be unfair on staff to expect them to compete with an organisation they may have to work for, if, in the event, it was an external bid that succeeded. However, also as best practice (7), if market testing and strategic contracting out offer similar savings at similar costs and all other things are equal, or if the option appraisal shows that the potential in-house bid offers significantly better value for money than other options, it may be better in the circumstances to look for rigorous internal restructuring, using benchmarking as a diagnostic tool. Contracting out should then be used in all other cases or if the expected improvements were not achieved. Whichever option is chosen, implementation will need to be kept under review, using benchmarking, to ensure that better quality services at optimal cost are in fact achieved. 10. Scoping and feasibility. Market testing and contracting out are procurement activities and the purpose of scoping includes deciding a procurement strategy which will best achieve the objective of better quality services at optimal cost. Scoping involves:   Developing the specification of requirements, including the expected innovations on the basis of research with customers/users, discussions with staff, and, informally, the private sector.   Maximising savings and reducing process costs by reviewing or exposing to competition as much of a service/activity as is reasonable and where possible packaging related or similar activities together.     Disproportionately high process costs penalise:   the public sector by eroding savings, discouraging private sector interest, in higher private sector prices from high costs elsewhere;   the private sector by reducing the scope or attraction in particular cases for private sector involvement;   customers/users by compromising quality and cost improvements.   Defining the relationship with the contractor. For simple, low-risk services and activities an arm's length relationship will often meet a Department's requirements. Where needs are evolving and so are the ways of meeting them, Departments may find useful a more open relationship where risk is shared and which enables both parties to work towards mutual goals. Such relationships are not soft options and require greater robustness and commitment than arm's length relationships. These relationships require the express commitment of Permanent Secretaries and Chief Executives. Such relationships are often called "partnering". (Note: formal partnerships governed by legislation, in which liabilities were shared would require a specially created joint venture company.)   Identifying risks and deciding (subject to negotiation) how risk is to be shared – risk sharing is a matter of placing risk with whoever can best manage the particular risk. Greater value will tend to come from a contract that enables a contractor to best manage identified risks (8).   Select a procedure permitted under EC Procurement Rules (9), which will normally apply, unless the value of the service over the life of the contract is below the relevant threshold or it is a "Part B" service.   The procedures permitted under EC Procurement Rules are, in outline: open procedure when anyone interested can bid; restricted procedure when only selected bidders can bid; negotiated procedure when the terms of the contract are negotiated with a short-list of selected bidders. The accelerated procedure should not be used unless these are exceptional circumstances.   The length of the process – efficiency exercises and competitions can take a long time. This should be considered in deciding when a competition should take place, to ensure that quality improvements and cost savings are delivered when required.   Phasing and scheduling – care will be needed not to launch a particular competition at the same time as others are launching similar competitions. The most experienced and innovative private sector organisations will not be able to respond to all competitions and may have to pass on some. Good relations with other Departments and the private sector (see below) should enable well-informed judgements to be made about phasing and scheduling. Feasibility involves examining whether what has been decided will deliver better quality services at optimal cost. 11. Competition. The stages (10)are:   advertising in the Official Journal of the European Communities (OJEC) (11) and, as good practice, Government Opportunities (12);   selection of those to be invited to tender ("pre-qualification");   issuing the invitation to tender (ITT) (in framing an ITT, Departments must ensure with their legal advisers that there is no direct or indirect discrimination, contrary to the Treaty of Rome or other internal obligations);   bid evaluation;   contract award (successful in-house teams and successful bids from other Departments are awarded service level agreements (SLAs));   debriefing. Note: If there is an in-house team bidding, it must be kept separate from those running the competition at all stages. 12. Contract/SLA. The contract/SLA should include:   the services to be provided, expressed as outcomes;   performance standards expressed as outputs;   risks and their allocation;   terms and conditions ("sections" in SLAs) (13), including: price, period, termination and the consequences of termination, monitoring and management, change procedures and dispute resolution arrangements;   rights of access to documents by the National Audit Office (NAO) and internal auditors. 13. Contract management (14). When a contract is let to an external bidder, or a SLA is awarded to a successful in-house team or bid from another Department, the internal or external contractor is responsible for delivering the service and meeting the performance standards in the contract/SLA. Departments should monitor and manage the contract/SLA to ensure this happens, without "sitting on the provider's (15) back" or doing the work of the provider. A responsible officer should be appointed contract manager. Whenever possible the contract manager should have been involved in the competitive tendering process from the outset. The seniority of the contract manager and the size of the contract management team should be proportionate to the size and complexity of the contract. Excess contract management represents an unnecessary erosion of savings and a clog on the effectiveness of the contract in delivering continuously improving services. 14. Evaluation. The efficiency exercise and competition should be evaluated while it is going on and afterwards to ensure that the choice was right and that better quality and optimal cost are being achieved. Benchmarking should be used. The lessons learned should be applied in other efficiency exercises and when contracts/SLAs are retendered. 15. Retendering. Contracts/SLAs become due for retendering at the end of their agreed period, or on premature termination by either party in accordance with the terms and conditions agreed in the contract/SLA. Circumstances and requirements change and competitions should not be simply repeated. The opportunity should be taken to review: requirements; the brigading of contracts and services; and to look at whole processes rather than discrete functions. A new specification should be produced. The options (abolish, restructure, contract out, market test, privatise (see above)) should be fully appraised. A long-term view should be taken. Departments must be prepared to justify their chosen option on robust value for money grounds. When outsourcing is again the preferred option, there should be a competition among potential bidders. Insourcing 16. Whether contracted out work is insourced when the contract ends is an issue of value for money. In particular:   how would value for money be demonstrated? Whether through a competition or by other means, the Department's justification must be robust and stand up to scrutiny.   does the management capacity exist in the Department to take on the work or to mount a bid? Would it be an efficient use of those resources?   if there is similar work in-house which could be the basis of a bid, is it efficient, or is contracting out an option for that work?   if it were decided to hold a competition with an in-house bid for outsourced work, the in-house bid team must be kept separate from those running the competition and the bid must be treated on equal terms with other bids.   what would be the process costs? Could the Department afford them?   if the work were insourced, the contractor's staff might have to transfer into the Department under TUPE (see below). The recruitment provisions of the Civil Service Order in Council and the Civil Service Commissioners' Recruitment Code are not relevant when TUPE applies. Effects on other Departments 17. Knock-on effects to other Departments and the Exchequer as a whole may emerge when services are being reviewed, or in scoping an efficiency exercise, or – exceptionally – during a competition. These should be resolved by the Accounting Officers concerned, so as to improve value for money across Departments without compromising the procurement process. Neither should exercise a veto. People issues 18. The 12 Guiding Principles state that the energy, skill and commitment of staff are the best assets in modernising public services. Senior managers need to ensure that staff are properly motivated and trained to carry out efficiency exercises and supported in carrying through competitions and in dealing with any personal consequences. 19. Training: (16) The skills required by staff are covered by core competences, but staff will need particular expertise in negotiation and an understanding of procurement. Training should be made available and key staff should attend. 20. Expert support may be needed from lawyers, human resources, procurement and finance specialists, and, in some cases, economists. 21. Communication with staff should be regular and comprehensive. It may be a mistake to confine communication to times when senior management consider there is something to say, as these times may not correspond when staff – both those running efficiency exercises and competitions and those affected – want to hear what is going on. Corrosive rumours could fill the gap. Regular communication, even when senior managers think there is little to say, can avoid this. 22. Consultation and negotiation: there should be consultation with staff and their recognised trade unions, or other recognised independent representatives, about efficiency exercises and competitions. There should be negotiation with recognised trade unions on the issues for which they are recognised – usually the consequences for staff flowing from the efficiency exercises or competitions. Statutory rights of consultation or negotiation should be honoured in the normal way. 23. Preference exercises: at an early stage in an efficiency exercise and competition, it may be appropriate to ask staff their preference should their work transfer. This is only possible before the competition is under way and positions have been taken on the application of TUPE (see below). Private sector contractors might have grounds for complaint if key staff who could be needed to operate the contract had been cherry picked. Preference exercises should only be undertaken when there was a realistic prospect of redeploying staff and if, at the time of the exercise, staff would have enough information to make informed choices; otherwise they might be misled, and that might have damaging effects on morale and on the delivery of the services. Footnotes (1) See Partnerships for Prosperity: the Private Finance Initiative, HM Treasury, 1997 (2) Hansard, 4 November 1997, Col 94 (3) Depending on the nature of the service or activity under review. Other initiatives, such as Service First - The New Charter Programme, Better Regulation, or Investors in People, may also be relevant. (4) See Towards Best Practice: An Evaluation of the first two years of the Public Sector Excellence Programme 1996-98, Cabinet Office, 1998 (5) Appraisal and Evaluation in Central Government, "The Green Book", HM Treasury, 1997 (6) See the Competing for Quality Policy Review, Stationery Office, 1996 (7) See the Competing for Quality Policy Review, Stationery Office, 1996 (8) Partnerships for Prosperity, HM Treasury, 1997 (9) CUP Guidance Note 51, An Introduction to EC Procurement Rules, 1997 (10) CUP Guidance Note 40, deals with the stages of competition, 1997 (11) Unless the EC Procurement Rules do not apply - see CUP Guidance Note 51 - in which case, as good practice, notices can be posted in OJEC voluntarily (12) whether nor not the EC Procurement Rules Apply (13) see CUP Guidance Note 59D (14) CUP Guidance Note 51 (15) The Term "provider" covers both external contractors and in-house teams working under a SLA (16) CUP Guidance Note 53