Internal service fund functions: should they be required to compete with private vendors?

• Author: Davenport, Larry W.

When total costs to the government are taken into account, how do ISF costs compare with outsourcing?

Governmental organizations frequently elect to provide certain services on an in-house basis rather than utilize private vendors. For example, an internally operated print shop is often more efficient than having departments purchase printing services from private vendors. This efficiency is generally a result of the economies of scale and convenience of location which result from consolidating the process inhouse. In addition to print shops, governments commonly provide or perform other services in-house: typical examples include central garage, motor pool, data processing, and warehouse services. Oftentimes these services are accounted for as internal service funds (ISFs).

Pricing ISF Services

ISFs are used to account for the financing of goods and services provided on a cost-reimbursement basis by one governmental department/agency to other departments/agencies within the same government. The annual costs of providing an ISF service generally are estimated in the budget process, then established as the annual budget for the ISF. The budgets of the various ISF customer departments/agencies receive appropriations for that service which, in total, should equal the ISF's projected expenditures. In order to plan for the ISF to finish a fiscal year without a surplus or deficit, its charges to each customer should equal that customer's appropriations for that ISF service.

While ISFs may seem simple in concept, certain aspects of their financial structure often are not obvious to many government professionals. One area where lack of understanding is common involves the process of allocating ISF costs through user charges and the effects of such cost allocations on the governmental organization's bottom line. This usually manifests itself in the belief that if one can find a private-sector vendor willing to offer the same service as that offered by the governmental ISF at what appears to be a lower price, money can always be saved. The following discussion will explain why this may not be true and how utilizing such private vendors rather than the ISF can oftentimes substantially increase the governmental organization's costs for a given service.

If an ISF function is to finish a fiscal year without a surplus or deficit, its charges to customer departments should equal those customers' appropriations for that ISF service. To the extent that ISF customers purchase the service from a different vendor, the ISF will not realize all its appropriated revenues and will, therefore, incur a deficit. While a customer department shopping elsewhere might...