Five risks to cost saving from sharing services
Thomas Elston, Post Doctoral Research Fellow at BSG, co-authored a piece about shared services in public agencies with Muiris MacCarthaigh.
Shared services are a popular reform for public agencies under financial pressure. The hope is to reduce overheads and increase efficiency by consolidating support services like HR, finance and procurement across multiple organisations. However, research suggests that there are a number of reasons why shared services won’t always live up to expectations.
Efficiency pressures in the public sector have intensified since the global financial crisis. Declining budgets and rising demand for public services mean that many governments around the world are looking for significant cost-savings from re-organisation.
One of the most popular solutions is ‘shared services’. Widely favoured in the private sector, this involves removing an organisation’s administrative and/or professional support functions to a specialist provider, who then offers the same services to multiple clients. The aim is to reduce duplication in areas like human resources, finance and procurement; harness economies of scale; and promote investment and professionalisation.
Despite some noteworthy success stories and widespread enthusiasm among consultants and policy institutes, it is increasingly apparent that shared services are no failsafe solution. Delays, cost overruns and deteriorating service quality are commonplace, and disillusionment is beginning to set in.
Peter Gershon, the British businessman and former government adviser who initially recommended shared services in 2004, later conceded that difficulties in implementation mean the reform ‘should only be undertaken on a very carefully selected and controlled basis.’ Problems have also occurred in Belgium, The Netherlands and Estonia, and the Australian government recently cautioned that: ‘There are plenty of examples ... where a good idea that is not well implemented leads to increased costs and/or poorer service standards.’
By analysing the growing number of shared service ‘problem cases,’ as well as relevant academic literature, we have identified five factors that can get in the way of shared services reaching their cost-saving potential.
1. Escalating start-up costs due to path dependence
Sometimes shared services projects are delivered on time and budget, but often there are delays and significant cost overruns. These reflect the difficulty of refashioning organisations to enable shared back-offices.
One specific problem is what social scientists term ‘path dependence.’ This occurs when following a particular course of action in an organisation produces consequences that make the same path more attractive in future. This creates change resistance. It is easier and cheaper to continue in the same direction than undertake a strategic about turn.
Sometimes, an organisation’s prior investments can be a source of path dependence during shared service reforms. For instance, existing information technology used to support back-office operations might need to be scrapped in favour of a new common platform. This could mean re-training staff and abandoning a system that has yet to run its full economic life, both of which are costly and provide incentives to retain the status quo.
Alternatively, path dependence can arise when there are interconnections between different processes within an organisation. For example, payroll needs to be able to “talk to” pensions. These interconnections make it difficult to isolate and replace one small part of a larger system; change in one place requires change elsewhere. Consequently, it might be cheaper to maintain an out-dated but connected system, than to completely re-build it.
By whatever route, path dependence makes change difficult in organisations. In extreme cases, so great are the costs of breaking the “lock-in” effects that, were they foreseen at outset, the reform would never have been approved. For example, shared services in Western Australia cost £185m more than planned. The project was eventually scrapped in 2011.
2. Increased transaction costs
A second reason for shared services to cost more than planned is that business cases for reform rarely take account of transaction costs.
Organisations incur both “production costs” and “transaction costs.” These reflect the activity involved turning inputs into outputs, and the activity of arranging and monitoring those processes. Both costs should be minimised, but often there is a trade-off. Contracting a service to a third party lowers production costs due to scale economies, but can bring higher transaction costs than if managers oversee the work directly.
Sharing services creates various extra transaction costs. Initially, great effort might be needed to document how the back-office currently operates and write this into a specification for the shared service centre. Then, there are transaction costs in setting performance targets and monitoring the provider, in periodically adjusting service level agreements, and so on.
In terms of the overall efficiency of a reform, it is the balance of production costs and transaction costs that matters. Reformers often overlook this trade-off, focusing on scale economies rather than the transaction cost burden for organisations. Research in America recently attributed disappointing savings from shared services to this problem.
3. Reduced service quality
A third problem comes from the side effects of standardising back-office processes between organisations. Standardisation is important to achieve economies of scale, and is enforced through strict rules and regulations. But it also brings several difficulties.
In particular, research into the sociology of organisations indicates that heavily-regulated institutions can suffer from excessive concern for processes rather than outcomes, slower decision-making and decreased innovation – all of which inflate costs, as well as damaging the organisation more generally.
As one of our interviewees reported: ‘[When you have] a great big, monolithic supplier ... then you start getting Shared Services and Procurement having policies and ideas of their own, and their idea about what your business should be. And [they] stop acting like the provider, and start acting like the customer.’
4. Functional duplication
Fourthly, shared services can disappoint if, despite the move to a single provider, individual organisations continue to duplicate back-office functions in-house. This lowers the volume of shared activity and so undermines scale economies.
There are many possible explanations for duplication. Some argue that managers naturally prefer autonomy, and so try to retain capacity in-house (potentially renaming the function in order to avoid detection). Others contend that, if the standardised offer from the shared service centre is inadequate for the individual organisation, or if the reform investments and transaction costs are too high (see above), then managers have more legitimate reasons to duplicate functions in-house.
More research is needed to determine the prevalence of these conflicting reasons for duplication. For now, though, it shouldn’t be assumed – as it often is – that bureaucratic fiefdoms and inertia are necessarily to blame when “shadow teams” emerge in organisations.
5. Opportunity costs
Finally, opportunity costs are a less direct threat to cost saving.
There are opportunity costs to any reform strategy – especially in the current fiscal climate. Human and financial resources are limited, and leaders face choices and forego alternatives when one option is selected over another. So the question is: by focusing particularly on creating shared service centres, what reforms are being shelved, and is this sacrifice worthwhile from a cost-saving perspective?
For example, the major restructuring required for organisations to share a common back-office might distract from the underlying aim of streamlining complex administrative processes, or might divert attention away from the much greater challenge of reshaping frontline systems and processes (where the majority of public money is spent). Consequently, less resource-intensive alternatives to full shared services might be more productive if they produce some cost savings and free up capacity for other reforms to be pursued simultaneously.
To conclude, our research does not show that the shared services approach is inherently flawed in the public sector context. That is certainly not the case. But it does question the widespread presumption that shared services are a viable and valuable cost-cutting solution in every scenario, no matter the context. History tells us that the popularity of a reform idea is, unfortunately, no guarantee of its efficacy, and this is certainly true with shared services. Ultimately, there is no substitute for hard-headed, critical analysis of costs and benefits in particular circumstances; and the five risks we identify above should help managers with this important task.
This is an edited version of an article in the July 2016 edition of CIPFA’s professional journal, Public Money & Management. A fully referenced version, with more examples and analysis, is available here.