An Interactive Tool for commissioners, investors & providers

1B. Can payment by results reduce costs/improve value for money?

PbR, in this country in particular, has mainly been used for public services whose budgets are being substantially reduced, with the result that there has been more focus on PbR as a cost-cutting mechanism than on its ability to improve value for money (getting the best outcome for the best cost).

But do PbR schemes save money?

Improving value for money

Of course, if PbR schemes achieve their outcomes (as some do and many don’t), they do represent good value for public money since, for instance, a dependent drug user in recovery makes a much reduced demand on a wide range of public services.

However, PbR has been increasingly used as a mechanism for cost cutting – both the Work Programme and the newly privatised probation system (known as Transforming Rehabilitation) introduced PbR contracts at the same time as very substantial budget cuts.

Cutting costs

However, much of the research warns against using PbR solely or predominantly for cost cutting.

A review on the lessons to be learnt from (the many) Australian workfare schemes recommends strongly that such schemes should not be competed on price for three main reasons:

  1. It encourages “gaming” with would-be providers over-promising and subsequently under-delivering.
  2. It drives down quality and, consequently, performance.
  3. It strongly encourages providers to respond to under-priced contracts by creaming (focusing on the easiest to help end users who may have found work without government intervention) at the expense of parking (providing a very minimal service to) those who are harder, and therefore more expensive, to help.

A common theme in the literature is “the winner’s curse,” a phrase used to describe the phenomenon where a bidder (typically for a very large government contract) prices their offer at such a low level to win the contract that they subsequently find it impossible to deliver an effective service within budget.

The research suggests that this is a particular risk when a service is commissioned on a PbR basis for the first time. The key lesson for commissioners is that in these circumstances:

“Fixed-price competition based entirely on quality may be more appropriate”

The key lesson for providers is to carefully cost their model of provision and not to compete for services which would only pay their way with an improbably high level of outcome achievement.

A recent US study which examined the growth of Social Impact Bonds (SIB) or other types of private or philanthropic investment vehicles to fund Pay for Success schemes found that the SIB approach often entails considerable extra expense.

The complexity of schemes often entails transaction costs beyond the loan and interest of funding, including the cost of legal services, evaluation, programme administration and loan management. The study notes that these costs may incur considerable extra costs compared to a direct commissioning approach and that many State governments are effectively paying a considerable premium in order to access private finance up-front. Investors and commissioners need to be sure to take these costs into consideration when developing a new PbR scheme.

Conclusion

One of the key themes which emerged from the literature is that although payment by results may often be an effective commissioning approach, it needs to be carefully planned with a clear rationale.

Currently, as the National Audit Office found in its 2015 rigorous overview of PbR, too many schemes are not carefully planned and are driven through because PbR is championed by government and is thought to cut costs. The NAO makes it clear in its conclusion that:

“Commissioners may be using PbR in circumstances to which it is ill-suited, with a consequent negative impact on value for money.”

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