Why Tesco Gets Economies of Scale, but the Government Doesn’t

In: BlogDate: May 17, 2015By: Henry Stewart

Those who believe government can reap economies of scale often quote the example of Tesco.

For example, Colin Cram wrote in his Guardian piece this week in favour of shared services, “Where do we spend most of our money – at Tesco or in corner shops?”

The first problem is that retail does appear to show benefits to size but it is the exception. If you get legal advice from a small firm, you expect it to be cheaper than a big city lawyer. If you found a local IT consultant, you know they would be charging less than IBM. Generally you can ask why, if economies of scale are so effective, are services from large companies more expensive than those from small ones?

The second problem is that the government’s approach is very different from Tesco’s. Imagine for a moment if Tesco’s purchasing was run in the way government runs its procurements. Tesco achieves its low prices through thousands of direct relationships with suppliers, with whom it drives hard bargains. The government approach would be to scoff at the large number of suppliers: – “Far too complex, we need to rationalise them.”

They would, for instance, put out a tender for a company to run the refrigerated foods section. “It’s far too inefficient to deal with all these different companies,” they might say. “Instead let’s get in a large management company to secure economies of scale.” This company would in its turn subcontract the dairy section to an expert in that field and they would in turn purchase the yoghurts from a third supplier. They would do away with this idea of many types of yoghurts (government procurement never involves providing choice) and instead select one ‘best of breed’ yoghurt provider who would be given a 10 year contract to be the sole provider of yoghurt in all Tesco stores – government always goes for long-term contracts, to incentivise the supplier to make the necessary investment.

The result would be a less good service to the consumer, and greater cost as the costs of all three layers of suppliers had to be met. I guarantee that Tesco would no longer be cheaper than the corner shop. And if the quality of that sole yoghurt provider fell, it could only be remedied through the complex legal contracts, and indeed only by three layers of legal contracts. (Tesco would be more likely to tell a yoghurt supplier with a problem “Sort it or you’re out.”)

I do not exaggerate. All this is based on my personal experience.

Rationalising suppliers: In the Apprenticeship market, the government has rationalised by refusing to sign a contract with any training provider for less than £500,000. All those with smaller contracts have had to merge or cease provision.

Large management companies: This is the standard government approach, which somehow presumes layers of suppliers with one overall management company provides “economies of scale” rather than bureaucracy and cost. I am Chair of Governors of a school that went through BSF (Building Schools for the Future). Schools were not allowed to buy the different elements direct but were forced instead to select a managing company who would in turn sub-contract to cleaners, ICT support, builders etc. The result of these “economies of scale” was that ICT support became both more expensive and less responsive than it was before.

Local schools not involved in BSF either employ their own ICT staff or sign one year contracts for support so they can get out easily if the supplier isn’t up to scratch. Our ICT support was truly dreadful but we had been forced to sign a five year contract and, though we did get substantial penalties, it was virtually impossible to get out of. Indeed we didn’t have a contract with the ICT supplier. Instead they had a contract with the managing company who had a contract with the LEP (Local Education Partnership), who had a contract with the local council, who in turn had a contract with the school. We would have had to trigger break clauses in four complex legal contracts to get out of it.

The reality is that, in most areas of government supply, small businesses are more flexible and better value than large ones. If our school could have found a good local ICT support company, it would have been far better value. And a one-year contract would have made them far more responsive. (I know of one government department who signed an ICT outsourcing contract of over 15-years duration. As a senior manager at the department said to me “We are one of their largest customers worldwide and they treat us like s**t.”)

Government procurement relies on a “big is best” approach on the illusion that some group of people at the centre can decide a “best of breed” to meet the needs of everybody and that complex legal contracts are the best way to get value and good service. (And the one thing you can be sure these big government suppliers are good at is the legals.)

There is an alternative. Short-term agreements provide a natural pressure on service that contracts never can. Instead of choosing a single “best of breed,” imagine if they set a quality threshold and a maximum price, but allowed more than one supplier (as Tescos ensures many yogurts are available) – ensuring the pressure of competition. But I don’t expect any government department to try this more sensible approach any time soon.

 

Postscript: My next two posts follow on from this:

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