Payment by Results: what are the key get rights prior to launching a successful programme?

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1 Payment by Results: what are the key get rights prior to launching a successful programme?

2 Payment by Results: what are the key get rights prior to launching a successful programme? This paper will be of interest to board-level commissioners of services across government, whether as commercial or finance leaders, or as the leaders of major programmes. In our paper Payment by Results: what commissioners need to do next we highlighted that commissioners and providers often have very different attitudes to commercial opportunity, risk and incentivisation. We identified three key issues that commissioners need to address in current and future programmes. We set out the major recommendations for commissioners to get better value from Payment by Results (PbR) mechanisms, which we explore in four separate supporting papers. PbR: Issues that commissioners need to get right There is a considerable amount of commentary about PbR in the public domain. Much of this is about the appropriate boundary between public and private sector delivery. Our approach here has been instead to identify practical insights for commissioners by comparing our own observations with organisations delivering PbR programmes on the front line: the provider community. We have talked to a representative sample of providers, covering both existing and new programmes and a range of organisational capabilities, from prime contractors to some of the smallest members of the voluntary and charitable sectors. We observe both a broad willingness amongst providers to engage with PbR programmes and an acceptance of PbR as a valid and useful payment mechanism for commissioners to deliver public service reform. We would expect its use to continue to be applied more widely. To use PbR successfully, however, commissioners need to grapple with what we believe are some of the fundamental drivers of failure or success: 1. Providers have to balance cost recovery, upside returns from successful innovation and risk pricing. Successful PbR rests on commissioners identifying an optimal balance between PbR risk and reward. Effective commissioners must better understand how the private sector prices and manages risk. 2. Increased provider adoption of PbR should not be misconstrued as the private sector enthusiastically embracing the concept. For commissioners, this has important implications for what types of providers will engage in PbR-based programmes and how they will think about pricing their bids. 3. PbR mechanisms are far more complex to calibrate than conventional payment mechanisms. Commissioners therefore need to steward their programmes over time, from initial selection of PbR, through commissioning, to programme management and exit/recommissioning. There is a considerable body of good practice literature on how to run procurements to outsource public service delivery. In this paper, we focus on those elements most needed to set up and run a procurement using PbR as the payment mechanism. 1

3 Launching a successful PbR-based programme PbR procurements are different from conventional procurements because of the emphasis on the need for providers to innovate to improve social outcomes, on top of the need to deliver operational improvement to drive service efficiency. As discussed in previous papers in this series, the required service innovations are generally needed to address complex social problems for which there are no clear solutions. Commissioners therefore need to create a procurement environment in which providers can think deeply about how the services should be delivered differently in the future and how they should then price their services. This can only be based on a well-grounded understanding of how services are delivered today. To create this environment, commissioners of PbR programmes need to focus on three important areas. Key get rights for a successful PbR launch 1 Create the environment for providers to innovate. Invest up front in understanding the end-to-end value chain of current arrangements and how they are intended to work in the future. 2 Make the right data available. Provide an effective data room that meets the best practice of a vendor due-diligence approach. 3 Manage the supply chain. Develop a supply chain commissioning strategy to ensure the supply chain is sustainable in the new model. Create the environment for providers to innovate PbR-based programmes typically start with a competition that awards the transfer of existing, fully staffed services to new providers. The ability of bidders to understand what they are taking on is critical to the future success and value of the programme. The bigger the information gap for bidders, the more cautious they will be about what they offer and, conversely, the greater the risk arising from any poorly informed bids, which increases the prospect of disruptive market failure in future. Commissioners have a critical role baselining the current system performance. They also need to be clear about how this current system baseline links to the areas in which they are prepared to see innovation and what they are prepared to reward through the PbR payment mechanism. This is illustrated in the diagram on the right and expanded upon below. To achieve this, the appropriate baseline data and analysis are needed to strike the right balance between the commissioners appetite for new solutions and the bidders need for sufficient confidence in their future revenue model. Current System: It is critical for providers to understand the current system in order to size their proposed operating model. Equally, it is critical for commissioners to understand how providers have done this if they are to evaluate whether the proposed operating model will deliver a solution that is achievable and sustainable. In practice, this means commissioners must invest before the competition begins in fully understanding and documenting the relationship in the current system between activity, resource, cost and outcome including the value delivered by these outcomes. This information can be hard to collect and difficult to analyse properly. The temptation is therefore unwisely to skip or move on from this step before it is sufficiently complete. Current system (Activity Resources Innovation (Permitted/Constrained) Costs Outcome) PbR (Retained/Transferred Risk, Timing & Incentives) In summary, for an innovative future service delivery model to succeed, it must be well grounded in the operating model in place today, together with the measured activities and outcomes. 2

4 Innovation: We encounter confusion in bidders around whether they will be able to innovate sufficiently and where. Commissioners need to make this very clear early on in the process and, conversely, highlight where there are genuine constraints to potential supplier operating models. In order to evaluate supplier proposals, there is a clear obligation on commissioners to work through up front what types of innovation are acceptable and expected of bidders; it is not acceptable simply to expect the supplier market to innovate independently of a clear understanding of what types of innovation commissioners will value or otherwise. PbR: PbR mechanisms are simple in concept, but difficult to design in a way that genuinely incentivises providers to behave in a way that is intended we discuss how to address this in the related paper in this series Payment by Results: when and where is it likely to be the right commercial strategy? Suppliers will need to understand how innovation and risk-taking will be rewarded and the extent to which these are exposed to the PbR mechanism as opposed to fee-based payment for ongoing service delivery. Commissioners need to be explicit about which risks are intended to and can, in fact, be transferred to the providers; otherwise, providers will build into their operating models and price for risks over which they have no control. In turn, commissioners may then end up paying a premium under PbR for a supplier to manage a risk they are not actually controlling. Drawing these themes together, commissioners have an obligation, throughout the supplier engagement process, to show bidders in all tiers how the system would perform under a PbR mechanism today and in future, so that bidders can assess the achievability of what they are being asked to do. Bidder caution is understandable as they have to make the commercial case for a future business that does not exist today, often in the context of a market that is being radically reshaped. In practice, before launching a programme, commissioners need to invest in developing the evidence base for the procurement. In PbR programmes, there is an inherent delay between the activity and cost incurred (for example, securing housing) and the outcome achieved some period later (for example, sustained employment). If such data is not already being gathered well in advance of the competition, providers may be being asked to develop a solution where there is no evidential link between activity and outcome. This is unlikely to be a robust basis for commissioners committing providers to a PbR-based payment regime. To address this, commissioners need to take an analytics-led approach to the programme, whereby structured data gathering about the current system starts before the programme even commences. This approach then needs to be sustained, even when the system has been transferred to the market. Make the right data available Under a non-pbr procurement, providers can, to some extent, rely on well understood benchmarking of commoditised services to size their operating model and thus price their solution. In PbR-based programmes, especially those in their first generation, no such benchmarks exist, so providers are wholly dependent on information provided by the commissioners. Commissioners therefore have a pivotal role managing the flow of information, data and analysis to providers. This is especially the case where the work has been broken into multiple lots and the providers have options about which lots to bid for, increasing the 3 amount of information needed by the bidders. This is compounded where there is likely to be an extensive supply chain. These factors limit face-to-face interaction between commissioner and bidders, increasing the need for bidders to rely on accessing the right information electronically. During the pressure of a major procurement, the way that this data is actually made available is an important factor in its own right. In practice, this means commissioners need to set up and run a best-in-class data room. From our discussions with providers about PbR, they are very clear about what this needs to look like.

5 What bidders want from an effective data room 1 Data prepared to the standard of a commercial vendor due-diligence approach (where the seller prepares the data, rather than each buyer sending in their own due-diligence team). 2 A programme of active management of bidder expectations about the quantity, quality and timing of data availability. 3 Early sight and a walk-through of the proposed data room structure and the opportunity to provide feedback, with rigorous control to be maintained thereafter over the data room structure, with clear signposting to the bidders about content and updates. 4 Quality control exercised centrally over data being provided, with gaps actively managed by the programme team. 5 Where there are multiple equivalent lots available, data provided in a consistent and standardised form so that bidders can quickly compare and contrast them on a like-for-like basis. 6 The data room to be populated fully with the core data by the time the Invitation to Negotiate (ITN) is issued, with minimal updates during the competition. 7 Inclusion in the data room of any material that reduces the need for site visits and/or the time needed to engage with existing management to gather primary data (enabling the limited time available for site and management visits to be focused on exploring risks and issues etc.). 8 Minimising the size of the data room by including in the data room only the information that is directly relevant to the requirements. 9 Information made available to all members of the provider community, not just those involved in prime negotiations. Second-and third-tier providers, especially the Voluntary, Charitable and Social Enterprise sector (VCSE), need help navigating the data room. 10 Reviewing the security marking rigorously to ensure that only genuinely sensitive information is protectively marked, making it much easier for the providers to use. In practice, we have rarely, if ever, seen these guidelines being met. Providers tell us that their experience falls short of leading practice around data provision, citing many cases where information has been late, incomplete, unfiltered or unmanaged. The implication of this is that bidders bid against an incomplete information set and then overprice/underprice their risk or simply mis-size their operational solution. One approach to this problem that we have observed is providers recruiting individuals from the existing service, but this can potentially result in the service being destabilised before it is transferred to the market. Bidders are especially wary of entering contracts that require a Day One performance improvement, often to levels never delivered historically, with the full rigours of the PbR regime applying from the start. 4

6 Manage the supply chain Current PbR programmes are based partly on the assumption that the best innovation for what works lies in small and medium enterprises, such as the VCSE second-and third-tier providers. The ideal solution for commissioners is therefore where Tier 1 providers engage with a wide range of Tier 2/3 providers, tapping into a broad base of innovators and then industrialising the best solutions. However, this approach may be highly disruptive to the Tier 2/3 providers and existing departmental providers may find they are cut off because: They cannot find a Tier 1 provider to join. The insertion into the supply chain of a Tier 1 provider who has to reduce overall costs and make a profit, may result in a disproportionate financial impact on the smaller enterprise. The smaller enterprise may end up taking all the PbR risk because it is the innovator whilst the Tier 1 provider takes all the fees for service. Smaller enterprises may simply be overwhelmed by the demands of having to engage with multiple potential Tier 1 providers in a competition and having to assess potentially different PbR contracts with each one. The challenge for commissioners, therefore, is how they enact a PbR programme without disrupting the very supply chain they are depending on and want to promote. There are choices as to how far they get involved in the supply chain to mitigate these risks, such as: Standardising existing Tier 2/3 performance information via the data room to help Tier 1 providers assess Tier 2/3 providers on a like-for-like basis. Creating an engagement and contracting framework between the parties such as the Industry Standard Partnering Agreement. Setting the specific financial terms applicable between the parties this provides stronger protection for Tier 2/3 providers, but could undermine the concept of PbR by ensuring providers get paid whether their innovations work or not. 5

7 We believe commissioners should go beyond these choices and should develop a supply chain strategy that clearly sets out the extent to which they are prepared to see failure amongst Tier 2/3 providers. If they are prepared to see failure, then an information-based approach may be all that is needed to facilitate joining up the tiers of providers. If they are not, then they may need to consider an alternative commissioning strategy, for example, whereby some or all these providers continue to contract directly with the commissioner for payment purposes, with the Tier 1 providers supplying only the operational environment in which to test their innovation (for example, through access to a trial cohort). The strategy should also consider carefully how the system will evolve over time. A further area within a PbR programme in which it is important for commissioners to work closely with the potential industry supply chain is the design and operation of the PbR payment mechanism. Many potential providers at all tiers have told us that the commercial implications of PbR payment mechanisms are insufficiently understood before contract award, and that this is especially the case for Tier 2/3 providers. In our view, commissioners need to design their PbR payment mechanisms so that they work effectively through the layers of the supply chain: The impact of the PbR mechanism should be modelled, shared and discussed collaboratively with prospective providers at all levels of the supply chain from the outset of the procurement process. Given the inherent uncertainty on Day One in any PbRbased contract (especially first-generation contracts), the PbR component should be proportionate to each provider s ability to quantify and price the risk. This may mean simply introducing the PbR component later in the contract term and then increasing its weighting as the contract progresses. The PbR mechanism should be explicitly designed to be monitored and recalibrated on a regular basis, to minimise the opportunities for providers at all levels of the supply chain to game the system. A particular issue arises where there is a perceived over-emphasis on the short-term value for money in the design of the PbR payment mechanism, for example, where payment is conditional upon immediate improvements to outcomes. This can lead to contract terms that are over-complicated, difficult to understand and harsh, to the point where the financial headroom to innovate and build capacity is missing. This problem is compounded as the diversity of the supply chain increases, because barely profitable prime providers have very limited funds to share with their second-and third-tier innovation partners, who also need to make a sensible return. 6

8 Next steps For providers and commissioners alike, PbR is clearly complex. Commissioners need to understand the provider market when choosing which programmes are suitable for a PbR-based payment regime, how to commission those programmes and how to sustain the programmes beyond the first generation. Further papers in this series contain our insights and guidance on the attitudes of providers and practical advice covering these issues, focusing on: Payment by Results: how do providers assess the commercial opportunity? Payment by Results: when and where is it likely to be the right commercial strategy? Payment by Results: how should commissioners steward a programme over the longer term? Please contact us if you would like to receive these extra resources or to discuss any of the issues raised here. Opinions set out in this publication are not necessarily the opinions of the global EY organisation or its member firms. Moreover, they should be viewed in the context of the time they were expressed. This publication contains information in summary and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgement. Neither Ernst & Young LLP nor any other member of the global EY organisation can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. Contact us 7 Matthew Watt Partner James Eliot Executive Director Tel: mwatt1@uk.ey.com Tel: jeliot@uk.ey.com

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