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Why the G4S Olympics screw-up proves that outsourcing is good

July 17, 2012 10 comments

Everyone seems very upset about the fact that private security firm G4S has not delivered as many guards as contracted to police the white elephant that is Sports Day 2012, with many people suggesting it’s an example of why outsourced contracts are terrible . I’m not sure they should. Let’s rewind on what’s happened here…

G4S was contracted by the London Organising Committee of the Olympic and Paralympic Games (LOCOG) to deliver 2,000 security guards, as part of total security staffing of 10,000 people. The requirement for private security was increased to 10,400 out of 23,700 in December 2011 for reasons that were left obscure at the time, but can be presumed to be down to some combination of fear of imaginary terrorists and the desperate need to prevent people bringing in off-brand merchandise.

The company agreed to the increase, having its existing GBP86m contract value increased to GBP284m. It then carried out 100,000 job interviews over the following six months for staff, but failed to find enough people available at the right time and willing to take the work. Eventually, it had to admit that it had massively screwed up by taking on a near-impossible task, was not able to meet the 10,400 requirement, and LOCOG (presumably with government help) has instead brought an unspecified number of police and 3,500 soldiers  in to make up the shortfall.

While detailed contractual arrangements for the G4S deal haven’t been published, people familiar with LOCOG say that its Olympics contracts generally contain two separate contractual penalty elements: 1) payment by results, so if you don’t deliver, your pay is scaled back; 2) reimbursement for the costs of getting someone else to finish the job if you can’t.

So we can reasonably assume, in the absence of evidence to the contrary, that G4S is getting its pay scaled back and paying for the police and soldiers to step in. There’s a standard rate of GBP55 per hour at which cops are billed out to festival organisers; while I’m not sure the Army makes itself available for hire on quite the same basis [*], the soldiers presumably should command something similar.

This double hit – less pay and much higher costs, offset by much smaller savings on wages for the staff that haven’t been hired – is reflected by G4S’s statement to the London Stock Exchange last Friday, in which the company said it expected to make an overall net loss of GBP35-50 million on the Olympics contract. According to FT Alphaville, the total profit for G4S if everything had gone according to plan would only have been in the region of GBP10m, or 4% of the revenue from the deal. In the best-case scenario for G4S, 96% of the GBP284 million paid by LOCOG to the company would have have been paid out in costs [**].

Net result:

1) Sports Day will still be going ahead with a full security contingent;

2) the net cost to LOCOG of the deal will be lower than if G4S had delivered, because of the impact of the penalty clauses;

3) the police and the army will also get decent reimbursement from G4S, so the taxpayer will win out to an even greater degree;

4) G4S will make a significant outright loss on the LOCOG contract, which is at least four times the size of the profit it would have made had everything gone well.

Had security staffing been carried out directly by LOCOG, there’s little reason to assume it would have gone appreciably better. G4S is probably the organisation in the UK with the most experience in recruiting security people for events, and this is one hell of an event; if the task were easy, they wouldn’t have stuffed it up so badly. Unlike G4S, LOCOG has a million other tasks to focus on to the same deadline, and no direct experience of recruiting security people.

LOCOG perhaps could have made the cops and the army part of the original plan – but then the taxpayer would be paying the full billing rate, rather than having G4S picking up the tab. Or it could have massively raised wages for everyone (including the people already hired, not just the extra people at the margin – I’m fairly certain this is why LOCOG and G4S didn’t go down that route once problems arose) - but again, the taxpayer would then be paying the full rate for everything.

In other words, the risk of failing to deliver on the contract was successfully transferred from the taxpayer to the private sector, without being significantly elevated. For just 4% margin, G4S was willing to assume the entire financial responsibility for the staffing project. The consequences of the epic failure fell entirely on their shareholders, and not on the taxpayers.

Conclusion:

The outsourcing model [***] has won the day, and the wicked private capitalists are the only ones to lose out. Hurrah!

[*] although I suppose this could be one way to offset the impact of military cuts in future.

[**] the only reason to take such a low margin on such a high-risk contract is as a loss-leader, with the whole world watching G4S’s performance as a contractor. Which has admittedly happened, although not quite as planned.

[***] when combined with tough contracts that have decent enforceable penalty clauses. Without them *cough*Metronet*cough*, it’s a terrible model and people who use it should be horsewhipped.