Analyzing the cost-effectiveness of managed competition: make or buy? That is the question many governments must answer in the ongoing quest to deliver high-quality services as efficiently as possible.

• Author: Crawford, Michael A.

Editors's note: This article is adapted from the author's book, Using Competition for Performance Improvement: A Resource Guide for Practitioners Advising Governments and Not-for-Profits, Copyright 2001, American Institute of Certified Public Accountants, all rights reserved.

As a public finance professional, you are increasingly pressured to consider the most cost-effective method of service delivery. Whether you are facing budget balancing demands or concerns over service delivery performance, the pressure to provide the highest quality service at the lowest cost is a constant one. One of the most heralded tools for addressing this pressure is managed competition, the process whereby governments compete with private firms to provide public services. The underlying premise behind managed competition is that unlike the public monopolies that dominate public service delivery, competition among service providers--public and private--provides an incentive to control costs, respond quickly to change, emphasize customer satisfaction, and embrace innovation. (1)

Like other public policy issues, competition has both supporters and detractors. The purpose of this article is not to argue for or against the use of managed competition in government. The fact is that more and more governments are considering competition as a means to reduce operating costs and improve service delivery. This means that government finance officers will be called upon to evaluate the cost-effectiveness of changes in service delivery. This article outlines a methodology finance officers can use to identify, accumulate, and compare the internal and external costs of service delivery.

What Is Managed Competition?

Managed competition is a strategy whereby governments compete with private sector companies, not-for-profit organizations, and other governments to provide public services. This generally occurs within the context of the competitive bidding process in which governments request formal proposals from potential service providers, including their own departments or agencies. Managed competition can result in a number of different outcomes:

* Privatization through outsourcing. Government outsources a service to another provider, retaining responsibility for that service.

* Privatization through divestiture. Government transfers a service to another provider, divesting itself of any responsibility for that service.

* Partnering. Government partners with another provider to provide a service in a shared delivery and/or responsibility relationship.

* Retention with reengineering. Government continues to provide a service, modifying its approach in order to improve service delivery, reduce operating costs, or both.

* Retention without reengineering. Government continues to provide a service as it has in the past.

* Reverse privatization. Government takes back or takes over a service from another provider.

The ultimate objective of managed competition is to provide the most cost-effective and efficient service, regardless of the provider. Unsuccessful attempts at introducing competition in government often result from knee-jerk reactions to political, economic, and human resource pressures. The key to successful managed competition is a well-structured, comprehensive, and fair competition process. A well-managed competition process should include four distinct phases: identifying competition opportunities, planning for competition, performing the cost analysis, and selecting and assessing the service provider (Exhibit 1). Although these phases are equally important to the success of the competition process, this article focuses on the one that is most relevant to finance officers: cost analysis.

A Four-Step Approach to Cost Analysis

The purpose of cost analysis is to determine whether or not cost savings would result from transferring a service to an outside provider. To calculate and compare service providers, you must be able to identify and accumulate both the costs of providing a service in-house and the costs of outsourcing the same service to another provider. Achieving a complete, accurate, and fair analysis of competition alternatives requires that governments follow a systematic process. This section outlines a four-step methodology for performing an effective cost analysis.

Step 1: Collect Cost Data

Although this probably seems like a no-brainer and probably is for large governments with sophisticated cost accounting systems, collecting the cost data necessary to perform the cost analysis can be a serious obstacle. Many governments, particularly smaller ones, may not be able to isolate the costs of particular services within their normal accounting systems. Unless detailed cost data for these services is available in source...