A Balancing Act

Contracting out services can benefit the bottom line, but not always. The trick is to figure out when it does and doesn't.

For some time now, politicians from coast to coast have been telling their citizens that they will make government smaller and thus cheaper. Great idea, but the devil is in the details, and many politicians don't go much further than promising to "cut out the fat," "introduce efficiency" and "walk the walk." We've never been clear as to exactly what that last one means, but it must mean something pretty inspiring as we've heard it used in speeches dozens of times over the past few years.

One of the tools that many states and localities have utilized to make their government smaller has been to contract out to private firms a variety of functions--from repairing technology to running prisons to painting street signs. This makes sense if the private sector can deliver services more efficiently than governments. And, certainly, there are a number of cases in which contracting out has been beneficial and cost effective. But this isn't always so. The trick is to distinguish one from the other. That can be difficult when there is a general assumption, as there is in some states, that outsourcing is always better and that the private contractors will do a good job and save the state money--even without close monitoring. "A lot of outsourcing is sold on the basis of saving money but nobody checks to find out that it does," says James Bowman, professor of public administration at Florida State University. "When there is information, it turns out it costs more to do it."

A growing number of governments are catching on and have begun shifting into reverse--or at least checking out the old assumptions more closely. In Nebraska, for example, state officials seem to be increasingly wary of assuming that private-sector employees will be cheaper than those on the state payrolls. "There is less contracting out," says Mike McCrory, director of personnel. He points to a project that was dependent on contract employees. When the governor agreed to increase the number of positions for information technology, managers looked at the numbers and saw there was an opportunity to replace old contract employees with the newly approved state employees and save Nebraska a solid chunk of money in so doing.

McCrory says he has given considerable thought to the question of why contracting out often doesn't work out well over time. Although the outsourced contract may be less expensive at the beginning, "when the contract becomes embedded, I wonder if we don't get significant price creep after a while."

That might have been the case in Nevada where the women's prison in Las Vegas was contracted out. The state recently stepped in to take it over. "The contractor couldn't continue doing the job for how much it was being paid," says Paul Townsend, a legislative auditor in Nevada, "The state felt that it could do a better job for less money."

In North Carolina, similar adjustments are being made when the numbers are checked out. "We've been looking a lot at contracts," says Charles Perusse, deputy budget director. "We're adding state employees and getting rid of contracts where it's a cost benefit."

Perhaps no state has been more focused on ensuring it is using contracts wisely than Michigan. A statewide effort began in 2003 to review all the state contracts that were being managed through the Department of Management and Business Acquisition Services. The basic premise was simple: Anytime contract employees were used to replace state employees, the decision had to be demonstrably beneficial to the state through a straightforward cost benefit analysis.

Some of the benefits of this effort are clear. The lab at the Department of Environmental Quality, for instance, had been contracting out a fair amount of its work and was paying out substantial contractor fees. "We did an analysis on what it cost," says Frank Ruswick, special assistant to the director at the department. "We found that by hiring some additional people and purchasing additional equipment we could do it more cheaply ourselves."

Similarly, Michigan's Department of Information Technology looked closely at a number of contracted services that cost the state about $20 million. By hiring 95 additional employees, the state was able to accomplish the same work for less than $10 million.

Going in-house doesn't always save an agency money. And that's the point. Joette Woodard-Yauk, director of capital renewal in Michigan, notes that there is now a refreshing non-ideological approach to making the decision about whether or not to contract out. "The beauty of it is that we're looking at the best business case," she says. "That's the way you should be making decisions--finding the best balance and the best of both worlds."

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