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Competition Needed in California State Government (SCA-15)

Testimony Before the California Senate Committee on Government Organization

Carl DeMaio, President and Founder

Sacramento (April 20, 2004) - Good morning. Mr. Chairman, members of the committee, I appreciate the opportunity to appear before you today. My name is Carl DeMaio, and I am the president and founder of The Performance Institute - a private non-partisan think tank based in San Diego. The Performance Institute focuses on improving government results through the principles of performance, transparency, competition, and accountability. The Institute has extensive expertise in the area of government performance management, working with tens of thousands of federal, state and local government managers every year to improve the performance of their programs and agencies.

We strongly support the legislation you are considering here today, Senate Constitutional Amendment No. 15, which provides California government the opportunity to “competitively source” government services that may be more efficiently performed by an outside provider.

Competition in government is not about rolling back the important responsibilities government has, but about reducing the cost of government while improving its performance. In the end, it is about giving government the tools to become a “smarter shopper” and using competition to ensure the state’s best resources – whether public or private – are tapped.

While we fully support SCA 15, to be sure that non-profits and other governmental entities can compete for work, we might suggest that a modification be made. Accordingly, SCA 15 can be strengthened in Part A of Section 1 by replacing the words “the private sector” with “non-governmental organizations or local governmental entities.” Doing so opens the competition to non-profits and local government bodies that might best be able to carry out those services.

Regardless of who wins the competition, the average cost savings to government is 30 percent. In the California Citizens’ Budget 2003-2005, which The Performance Institute co-authored last spring, we documented how if you chose state functions that have been successfully competed in other governments could save nearly $9 billion in the budget.

SCA 15 will keep the door open for California to those tap in to those savings. Our review of California’s Constitution has concluded that competitive sourcing does indeed fit within existing legal parameters. Passage of SCA 15 should put to an end the nagging questions from opponents of competitive sourcing and allow the state government to finally move forward with desperately needed competitions. We recommend that this committee subsequently consider additional legislation that would provide guidance on what services should be competed and the process by which competitions are held. A transparent reporting process should also be integrated into this legislation, ensuring that the Senate and Assembly maintain proper oversight on contracts.

As California moves forward with competitive sourcing, legislators should consider the following recommendations adapted from The Performance Institute’s October 2002 report, “Designing a Performance-Based Competitive Sourcing Process for the Federal Government,” which can be found in full online at www.performanceweb.org.

• Provide a General Competitive Sourcing Framework that Creates Three Paths to Competition
  California should provide a general framework for how competitions should be managed that provides three standardized paths for competition while allowing maximum flexibility on how an agency pursues those paths to competition.

  Path One: Direct Conversion
  California should be allowed discretion to directly convert an activity to non-governmental performance at any time for any reason. In this case, the agency management would have to marshal a clear business case as to why a decision to directly convert an activity was so clear as to consider continued government performance of the activity inappropriate.

  Path Two: Streamlined Competition Using Employee Conversion Organization (ECO) Vehicles
  In other cases, the agency may want to allow employees to transition into an Employee Conversion Organization (ECO) vehicle. Under this path, agency management would announce a direct conversion and employees would have the opportunity to form either a governmental or non-governmental vehicle to compete for the work. Should the employees win, their vehicle would be placed under contract and treated as a standard vendor to the agency.

  In order to make the ECO approach work, employees would be given a modest amount of support by the agency as they select their vehicle for competition, e.g. employee stock ownership plan (ESOP), transitional benefit corporation (TBC), etc. In addition to having the option of creating a private entity, employees could link up with a governmental or non-governmental vehicle using an existing ECO already under government contract.

  Path Three: Public-Private Competition
  The third path to competition would be used only when employees are unwilling, or it is not practical, to convert to an ECO vehicle. Under this path, a public-private competition would take place where the public sector employees would compete with private sector bids.

• Take a Function-based Approach to Managing Competitions
  A one-size-fits-all competitive sourcing process may not be the best route for the California government. Calculating costs, analyzing performance goals, and evaluating the competitive nature of a bid can vary depending on different kinds of functions. A premium should be placed on ensuring that a given activity is competitively performed given industry standards for that activity. Evaluating this question for a food service activity would be dramatically different than evaluating the same question for an IT activity. Put simply, the specific tools and techniques an agency uses to determine whether an activity is competitively performed may differ slightly based on the function being examined. As a result, California should establish an overall competitive sourcing framework and then promulgate best competition practices on a function-by-function basis.
  
• Create an Action-forcing Mechanism that Would Require Transparency and Accountability for the Cost Performance of Contract Winners
  At the moment, government pays very little attention to maintaining timely and accurate data over the life of a contract. This leads to little transparency and no accountability. In order for the winning Most Efficient Organization (MEO) or contracting entity to be held accountable for its performance and cost, contract data, including personnel records, cost records, and workload data, must be constantly and accurately maintained through an action-forcing mechanism, such as a threat for re-competition. The losing bidder of a competition should have the right to review the performance and cost achievement of the winner over the life of the contract by examining agency data. Agencies that do not maintain these records should have to re-compete the contract. Should the winning entity be partly responsible for the lack of data, during the re-competition, it should be ineligible to compete. After all, poor financial and performance management should disqualify a bidder from the start.
  
• Communicate Clearly the Need for Performance-based Competitive Sourcing
  Competitive sourcing is controversial for government employees from the get-go and presents a complex communications challenge for managers. Deciding what to outsource inevitably raises philosophical questions on the size, scope and appropriate role of government in society. Without an effective communications and outreach initiative in each agency, competitive sourcing initiatives might suffer and fall victim to philosophically-motivated political debates.
  
• Use Performance Measures in All Competitive Sourcing Initiatives
  Competitive sourcing is ultimately designed to improve the performance of government. As such, competitive sourcing initiatives should yield cost savings (as defined by reduction in cost-per-unit output) and/or improved performance(as defined by improved service levels of outputs or enhanced impact on intermediate or end outcomes.) Agencies must clearly define end, intermediate, and output performance measures up front to guide the competition.
  
• Use the Agency Human Capital Plan to Inform the Competitive Sourcing Strategy
  The agency’s competitive sourcing efforts should be aligned to the agency’s human capital plan. Indeed, the development of the competitive sourcing plan should occur concurrently with the development of the human capital plan. In those commercial activities where the agency identifies a current or projected human capital shortage, competitive sourcing should be considered as one process for either streamlining the function or converting the function to an outside source where human capital can be accessed.
  
• Allow workers to keep pensions and other benefits through innovative vehicles such as an Employee Stock Ownership Plan (ESOP) and Transition Benefit Corporation (TBC)
  A major negative impact of competitive sourcing can be workers’ loss of employment and associated benefits. Total loss of benefits need not occur. A number of innovative vehicles (such as TBC and ESOP) could be accessed to transition employees into the private sector complete with benefits.
  
• Support Agency Competitive Sourcing Initiatives by a Change Management Philosophy
  It is vitally important that agency management employ change management techniques in designing, implementing and communicating competitive sourcing initiatives. Effective communications are vital to keeping employees informed and involved in a change as potentially significant as a competitive sourcing study. Most importantly, agency leadership must ensure credibility in assuring workers that the agency views individuals as valuable assets and take steps to reinforce that view throughout the competitive sourcing process.
  
• Provide Incentives and Bonuses for Employees through “Efficiency Dividends”
  Cost savings achieved during the first two years of a competitive sourcing initiative should, in part, be invested into employee bonus pools to be distributed with employees involved in successful sourcing initiatives. Three kinds of bonus systems should be devised: one for employees who staff a governmental ECO, one for employees who win a traditional public-private competition, and one for contract and program managers overseeing an outsourced activity. Obviously in the first two cases the government would be recognizing and rewarding innovative and efficient management by employees after they win the competition. In the third case, the government would be recognizing the importance of recruiting and properly compensating business leaders at the contract and program management level.
  
• Require Agencies to Clearly Identify Risk Factors Relating to Commercial Performance of an Activity that Reasonably Could be Deemed Inherently Governmental and Prescribe Oversight Strategy
  One way to create a solid business case around categorizing activities as inherently governmental or commercial is to clearly identify the risks to the public good in having a commercial entity perform a certain inherently governmental activity. In addition to stating the risks associated with outsourcing the activity, the agency should certify that there is no reasonable means of oversight and accountability that could be used in conjunction with an outsourcing initiative. For example, risk could be mitigated by an oversight board consisting of appointed officials and/or through independent performance evaluations. Risk factors include, but are not limited to, the following: assurance that official rules of law are followed, national security concerns, establishment or definition of government policy, civil liberty and privacy concerns.
  
  For those risk factors identified for the activity, should the agency decide to keep the function in-house, specific performance measures should demonstrate how well the agency is managing those risks. At the same time, the risk factors should be measured if the activity is ultimately outsourced. In both cases, the agency will be accountable for its decisions relating to inherently governmental activities.
  
• Allow Agencies to Keep Cost Savings from Competitive Sourcing Automatically
  By not allowing agencies to keep a substantial portion or all of the savings, the competitive sourcing process provides little funding for reinvestment in existing programs and provides no positive incentive for undergoing competitive sourcing. Instead of allowing agencies to keep the full amount of savings during a two to three year period as some have suggested, it is better to allow agencies to share in the savings (perhaps 50%) over the five year period of performance of the contract. This would ensure that agencies do not front-load cost savings in the first few years and offset savings in the out years. Additionally, agencies should be required to use their cost savings to reinvest in employee development and other management improvement initiatives for the agency.
  
• Create a “Competition Corps” to Assist Agencies in Implementing Competitive Sourcing Projects
  California should create a “Competition Corps” of highly trained competitive sourcing managers who would be assigned to each study conducted by the agencies. Similar to the public defender/ judge roles of the justice system, the Competition Corps would assume two roles. One manager would be assigned to assist employees in the development of an MEO or ECO and another manager would serve as the independent reviewer of the proposals. The Competition Corps would be financed by a fee charged to each agency. By consolidating expertise for managing competition into a central entity, the government can achieve economies of scale, foster maximum competency for managing competitions, and ensure a consistently applied process state-wide. Ideally, the Competition Corps would be organized into “functional” Centers of Excellence where staff would develop specific and honed expertise in management improvement, cost calculation, performance measurement, and proposal evaluation in key commercial activities.
  
• Set Goals and Measure the Success of Competitive Sourcing Initiatives Based on “Cost Efficiencies” and “Performance Enhancements”
  What gets measured gets done. Accountability for results is a fundamental ingredient to drive management change in government. Specific targets—when supported by thorough analysis—are quite helpful. Targets should be bolstered by a business case that takes into account cost drivers, program performance deficits, changing customer needs, etc.
  
• Prioritize Activities and Functions Scheduled for Competitive Sourcing Using a Transparent Business Model
  One way for agencies to identify where to begin applying competitive sourcing, and later to help decide whether to use public-private competition or direct conversion, is shown in the figure. If an agency has done a good job of analyzing how important an activity is to meeting the agency’s performance goals and also analyzed how well the activity is performing, it can plot the activity in the graph. The more important the activity is to the agency’s overall performance, the higher on the graph it is. The better the activity is performing, the farther to the right on the graph it is.
  
  Based on which box the activity falls into, an agency can determine what opportunities for change may exist.

o Attention Needed—Activities plotted here are important to the agency’s overall performance, but are not performing very well. These activities are prime candidates for competition designed to improve activity performance.
o Proven Success—Activities plotted here are important to the agency’s overall performance and are performing very well. Enough said.
o Exit Opportunity—Activities plotted here are not important to the agency’s overall performance and are not performing very well. The agency may choose to shift resources to more important areas after ceasing these activities and allowing the private sector to meet any demand for them.
o Resources Available—Activities plotted here are not important to the agency’s overall performance but are performing very well. The agency may have resources and staff here that can deliver similar high performance in more important activities and again may choose to shift resources to more important areas after ceasing these activities and allowing the private sector to meet any demand for them.

• In Terms of Cost Calculation Methodology, Require the Use of Activity-Based Costing (ABC) or Equivalent Cost Management System (OMB)
  All commercial activities should be supported by activity-based costing (ABC) or an equivalent costing system within three years or should be placed on the priority list for competition or direct conversion. As a requirement for public-private competition, ECOs and MEOs should submit their bids consistent with an ABC or equivalent costing system.
  
• Assess Risk Factors to Government Bids when Assessing Them on Private Bids
  In order to maintain equivalency in the competitive process, risk factors need to be determined and assessed to both the public and private sector bids, requiring a more thorough and robust technical evaluation of each bidding entity.
  
• Establish a Clear Performance Framework for Each Activity Competed
  No competition should be conducted unless clear measures of performance are established for the activity being examined. The performance measures used during the competition phase should be included in the performance-based contract governing the winning bid.

The Performance Institute is a private think tank seeking to improve government performance through the principles of competition, accountability, performance and transparency. The Institute serves as the nation's leading authority and repository on performance-based management practices for government. Its mission is to identify, study and disseminate the leading management innovations pioneered by "best-in-class" organizations.

Carl DeMaio is President and Founder of the Performance Institute. He is a nationally-recognized expert in government reform and performance-based management.