The Guardian has reported that:
Nearly £1bn has been wiped off the value of the government contractor Capita after the company issued a shock profit warning, axed its dividend payout to shareholders and said it needed to raise £700m to put its finances back on track.
The grim state of Capita's financial position emerged just two weeks after the collapse of the construction firm Carillion.
In the latest blow to the outsourcing sector, Capita's new boss unveiled a radical overhaul of the group's finances, and gave a damning assessment of the company, which he said had become “too complex” and lacking in discipline.
The government is already anxiously saying that this does not make it the next Carillion, but the balance sheet hole that exists is not much smaller than that Carillion announced last year, and whether or not £700 million of new money can be raised and at what price is open to question when it is very obvious that the business model is not working.
This, take note, is also no minor business model. Like Carillion, Capita is on the frontline of outsourcing, in particular. And what is being said is firstly that this creates a situation too complex for a business to manage with, secondly, margins that are clearly not sufficient to sustain the company in business as it is. That's not a micro issue: this is about whether or not the whole frontier between the state and private sectors has been appropriately drawn for a couple of decades or more.
The compelling evidence of these two failures (and it is clear Capita has failed as it has been, even if it survives in another form) is that the boundary in question is in the wrong place.
What is more, the whole logic of outsourcing that works only if those working to supply services are squeezed on pay and conditions to the point where their working conditions are intolerable is also no longer viable.
This means three things. Firstly what the state does, and does not do, itself needs to be reappraised and much more needs to move in house.
Second, the pretence that good public services can be supplied cheaply on the basis of abusing the staff supplying them has to be consigned to history and drawn to a close as rapidly as possible.
Third, the questions on the relationships between government, tax, borrowing and money creation that I raise on this blog now need to move centre stage in discussion.
Carillion and Capita may not have intended to signal the end of a particularly nasty and inappropriate form of capitalism, but if that's what they might inadvertently do I will not be sorry. However, and as ever, the opportunity for change must be grabbed. I recommend my recent posts on the social economy and paying for it.
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Here’s an interesting article on the failures of outsourcing, and the benefits of not only bringing things in-house, but of real localism.
Communism ran out of road in the 1980’s, and now the whole outsourcing, indeed the whole “Washington consensus”, with its inhumane “Structural Adjustment Programmes”, has not only run out of road, but shown itself to be (politely) the blind alley (impolitely, the s**t creek) it always was, being based on exploitation of the workforce, and the false “one size fits all” assumption that “private always good; public always bad”, which far too often led to low cost, low quality, inflexible services from what were effectively new monopolies.
That’s a good story that. Love it when folk gain independence. Thanks, Andrew.
‘Independence’ is over rated and has become a loaded word associated with ‘laissez faire’, ‘failing services’ and ‘neo-liberalism’ to me.
The true state of human existence is I believe ‘inter-dependence’ as the writer Steven Covey tells us.
This is even true of our rapacious financial sector who inter-dependent with the corrupt services of the ratings agencies, weak regulators, lobbyists, ignorance and lawyers without whom they could not exist in their present state.
Apologies – omitted the reference:
https://www.theguardian.com/commentisfree/2018/jan/31/preston-hit-rock-bottom-took-back-control
Thanks Andrew
I get the Impression that Carillion and Capita don’t ‘do anything’ they are ‘money managers’ who suck wealth out of things -perhaps there is no more suction?
Nice way of looking at it Simon
In short: rent-seeking.
A rent is the extraction of value created by others and it is, by that definition, always an inequitable transaction. It cannot exist in a free market, and it cannot exist as a free-standing business model: someone, somewhere, has to be creating the value that the rent is extracting.
Unfortunately, creative accounting can keep a rent-seeker sucking for longer than it takes the corrective responses of the market – if any exist, and often they don’t – to effect a corrective action before there is a permanent contraction of the economy.
It is possible – economically-speaking, if not literally – for rent-seekers to suck all the way down to vacuum and the empty void.
Carillon and Crapita have entirely sucked dry the value-creating action of the taxpayer-funded services they parasatised; and their implosion will result in further value destruction.
This is what John Seddon (Vanguard Consulting and Whitehall Nemesis ) says at the end of his most recent newsletter on shared services:
“Finally I gave advice: If you are thinking about sharing services, don’t. Instead do as these examples did, study the services as systems, redesign them and if you need IT make it the last thing you do. Following this path will result in the big prize, far better services and much lower costs. If, subsequently, you choose to share these services you’ll also gain the much smaller saving from less of a common resource.
If you’ve already shared services, don’t worry, they can be redesigned wherever they are, and you will need the leaders to understand how to study and design; if they don’t lead it, it will never fly. A simple first step is to study how much failure demand there is, it will tell you how ineffective the services are and this should energise leaders to do something constructive about it.
If you’ve outsourced services to a private sector shared service then, probably, you’re already stuffed. Failure demand represents greater revenues for the private-sector provider as contracts are usually based on transaction volumes. Nevertheless insist that the provider joins you in studying the extent of failure demand and test their appetite for redesigning the services. Be open about the need to change the contract once a more effective design is developed. Going through the process will expose the attitude of the provider; are they a true ‘partner’? Be aware that getting out of the contract might cost a lot, as it has done for others.
When the shared services initiative started five years ago we were told it was going to save £2 to £4 million a year. We haven’t seen anything to match the promise; instead we are overwhelmed with evidence of failure. As time has gone on the promises become less ambitious. By contrast there is abundant evidence that public services can be massively improved while at the same time radically reducing costs and it can be done in months, not years.
While the shared services protagonists claim services will be designed around user needs — and often, would you believe, they use personas (imaginary people) and focus groups to do this — to design around user needs requires first of all thorough knowledge of citizen’s demands.
Shared services are IT-dominated. IT should be the last thing you do, not the first. Doing ‘Agile’ IT is merely doing the wrong thing faster. To separate technology management from operations management is a mistake. Technologists should be directly connected and subordinate to operations design. The techies like that, after all they think it’s cool to do stuff that works. You spend less and get more.
Demand is the big lever. Sharing services isn’t. You don’t need a business case or a plan. To improve services you have to study them — get knowledge — and then design them to be effective. Cast your mind over examples of ineffectiveness and ask yourself: if this had worked immediately for the user would it have been more efficient?”
It’s depressing that all this is known
Well, that’s the thing. It’s not all known. A bit like the really useful stuff you get us talking about here on this blog.
Everywhere people are going into shared services. Still.
You have to be very brave to go Seddon’s way. There are case studies. But people like Capita as you have pointed out are dug into the public sector like ticks. Holding back progress. Just like those in the economic academia and finance sectors who try to snuff your ideas out.
Good point
Hi PSR,
I work in IT and agree with the principle that you do the IT part when you have worked out what your optimum process looks like (I’ve worked on process flows etc. as a business analyst and it is very satisfying to eliminate the inefficiencies at this stage).
You describe “Agile IT” as “doing the wrong thing faster” which is curiously what its proponents also say of it 🙂 It has uses when the end state of the computer system itself is not well known and the best end state can be arrived at via a process of prototyping. However it does not work well where there are many process constraints which could have been identified before you started.
Thank you Neil for your honest and validating comment.
I was quoting John Seddon in reality (‘doing the wrong think righter’) from an email newsletter he does. He has written lots of good books about this sort of stuff ‘Freedom from Command and Control’ being one of them.
I’d echo all of that and know John Seddon’s stuff – sensible man.
I’ve been involved in outsourcing from way back in the early 90s when surprisingly some of it made sense. No-one would think of running their own national let alone International IT networks these days but organisations used to. Now we just call it the Internet. Made sense for someone else to do it for lots of people. Bit like power stations
However, then it grew to being the teams of IT people who developed the systems that supported an organisations systems. They knew pretty much how the organisation worked but were seen as Just an overhead so off they went. Losing a whole bunch of knowledge and loyalty in tbe process.
Then it grew to be whole chunks of organisations, both private and public. Starting with support functions such as HR and Finance and eating into core parts of organisations. Plus the virulent mutation called PFI
A bunch of us who had worked in this space, believe it or not ended up doing work trying to bail situations out that had as so often happens gone pear shaped. Something that has not really been mentioned here is the extent to which so many of these are about crude financial engineering.
So I’m a director – the outsourcer pays me a chunk of money and takes heads and assets off my books. Quick boost to profit and makes my return on assets and per employee look better. Share price and my performance bonus/options get a boost. Chickens in terms of increased costs, poor service and inflexibility do not come home to roost for a few years by which time I’m gone (average time in the job for a director…?). Meanwhile the supplier tops up their initial low bid by hitting you with a cost for change control everytime you so much as sneeze. PFI is of course primarily about shifting borrowing off the government’s books, regardless of longer term consequences
Even longer ago in 80s when we were doing Total Quality and then serious process engineering, we learnt that the biggest gains to be made were at ‘process boundaries’. Ideally one looked to minimise if not eliminate them. Shifting an entire process (or business operation) out into a different organisation is about the worst thing you can do. Claims of efficiency gains are invariably rubbish. If you are that inefficient, as suggested above, sort yourselves out rather than allow someone else to profit from your inefficiencies
PS Which it occurs to me, is also an illustration as to why the single market/customs union are so important. They’ve done a brilliant job in minimising those ‘process boundaries’ at country borders as importers and exporters know very well. The non-tariff costs as they are referred to. Bring them back and you’ll increase everyone’s costs. Something for the Brexit enthusiasts to think about. Or just flatly deny…
Interesting stuff Robin,
I worked in outsourcing in the late ’90’s and fully recognise much of what you say. Part of my job was to monitor contracted firms on behalf of a large corporation – to make sure the contractors weren’t rorting the customers in our name. Well, they were and what I eventually discovered was a form of corruption where the contractors had little or nothing in the way of Service Level Agreement obligations.
They got unbelievably favourable terms by way of their relationship with the corporate manager that awarded those contracts and he wouldn’t have reason to do that unless he was getting something back in return (or so one assumes). There’s a lot that can be hidden before things get out of hand. When they the did get out of hand, and I revealed the root cause of those problems, the situation became rather tense. A few unexpected resignations were announced but nothing more was openly acknowledged.
One of the systemic problems that can emerge in over-complicating supply is the proliferation of perverse incentives and opportunities to corrupt. As for the “crude financial engineering” that you mention. I was also employed as a contractor( via agency) and I recall that a group of us once asked a senior manager why the company paid our agents so much when it would be cheaper to take us in-house as staff. He then told us about “the hidden head-count” – his exact words. The hidden head-count that was there to satisfy certain accounting ratios, deceive investors and pretend that the company had fewer employees than it actually did. Pretending to “efficient” can be an inefficiently expensive concern.
Some interesting things to note in this one:
1. Richard Murphy tweets: “Guess who audits Capita? It’s KPMG, again”
I shouldn’t be laughing but…
2. A while back this comments forum involved an interesting discussion about which sector would lead the next crash. Well, in a way, we may be looking at the answer. To be clear I don’t think that the PFI sector is big enough or hot enough to precipitate a market-wide crash but then again this trend among PFI contractors is beginning to look systemic. The rot always starts somewhere and history may record this Carillion / Capita episode as the beginning of the end of an era. Who knows? If I was so inclined I might start shorting anything that is audited by KPMG.
3. Theories about the efficiency of markets (such as the ‘Efficient Markets Hypothesis’) assume that asset prices reflect all relevant publicly available information and that all the relevant information is publicly available. Now see these excerpts from the Capita story:
“Just two weeks after the collapse of Carillion, outsourcer Capita has shocked the market with a hefty profit warning” (shocked, no less).
“Meanwhile few City analysts spotted the problems at Capita, according to their share price recommendations as collated by Reuters. But hedge funds had been shorting the shares.”
“Earlier this month, Capita’s new boss met City analysts and seems to have made a good impression”.
“Numis (Securities Ltd) was so enthused it issued a buy note after the meeting”
https://www.theguardian.com/business/live/2018/jan/31/capita-profit-warning-shares-tumble-markets-nervous-eurozone-inflation-federal-reserve-business-live
So among all this publicly available information what is that the hedge funds knew that the City analysts did not? Or did they, or was it publicly available or what?
Only one thing is certain: this a rotten game.
Excellent points
And as for the EMH, the one thing we know is there is no such thing
Richard Murphy tweets: “Guess who audits Capita? It’s KPMG, again”
Do you remember your post on 19/12 noted the reduction in KPMG’s earnings and you estimated they set aside £96,000 per partner last year for legal fees etc?
Perhaps we are starting to see why?
Also I noticed in a tweet today of a table showing contracts received from the public sector (in the past 24 months) that pointed out that Capita were top in their category well ahead of Carillion. However the really interesting thing was in the Consulting category the big 4 accountancy firms were all in the top 6 with, you guessed it, KPMG at the top…
It’s not a good time to be at KPMG
I smelt the coffee and moved on in 1983
‘what is that the hedge funds knew that the City analysts did not? Or did they, or was it publicly available or what?’
Inside job. A rotten game as you say -unless there is a massive exogenous event, companies must know they are on the way out-so maybe it’s a question of sweeping up and on to the next one?
Vampire squid culture. profit without production.
“Inside job.”
Looks like it. For a start the new Capita boss must have known something that he wasn’t telling the City mob when they met earlier this month. It is also hard not to suspect that someone inside Capita was talking tho the hedge funds.
Buy side broker research is generally of a poor quality these days and the calibre or analyst is far lower than the buy side particularly the better resourced fund management groups and hedge funds. So the firms shorting will have not had access to better information they will just have used what’s out there differently. Also sell side is often compromised by keeping a good relationship with the company managagement (try and get corporate advisory work) whereas fund managers and hedge funds are just interested in making good returns so they are far more objective.
And you really expect us to believe that?
Then hedge funds read the accounts. It was clear from Carillion’s accounts – the huge recievables and the growing debt pile – that problems were growing, so the hedge funds began shorting. Then came the profit warning and still the usual commentators were not troubled. The data was in the market but only the hedge funds realised what it was saying. The data was there. The market was fairly efficient. However, to turn to this point from the professor:
“What is more, the whole logic of outsourcing that works only if those working to supply services are squeezed on pay and conditions to the point where their working conditions are intolerable is also no longer viable.
This means three things. Firstly what the state does, and does not do, itself needs to be reappraised and much more needs to move in house.”
This seems to suggest that you want the state to pay people less than Capita to do the same work.
How bizarre
I am ruing the exact opposite of what you are saying
Perhaps worth pointing out that paying more to workers who are properly employed in the public sector can of course be a good thing for the overall economy, depending on your view of the multiplier.
Indeed
Graeme says:
“It was clear from Carillion’s accounts — the huge recievables and the growing debt pile — that problems were growing, so the hedge funds began shorting. Then came the profit warning and still the usual commentators were not troubled. The data was in the market but only the hedge funds realised what it was saying. The data was there. The market was fairly efficient.”
Oh-my-God. I had to copy and paste that to check that it was real.
Only the hedge funds were capable of reading basic accounts and understanding them. All the City professionals the brokers, analysts, “usual commentators” and others – the ones that the public has access to (and rely on) – they are not capable of reading these things or simply ignore it all for some strange reason.
Yep, sure.
The market was so “efficient” that for months on end , probably longer, the share price of Capita did not come remotely close to reflecting the “available” data until a shock profit warning saw that it suddenly lost almost half of its value and plummeted to a 15 year low. And when the new Capita boss met with City analysts 3 weeks ago he didn’t share any basic, technical information with them because those guys can’t understand that stuff. He just showed them a cute PR video and they said ‘cool, I love it – lets issue a buy note’.
So “the market was fairly efficient” not as a market, but for the exclusive purposes of some secretive hedge funds with an exclusive clientele of millionaires.
Meanwhile, somewhere in a parallel universe known as Zog, none of this has happened and everything is just fine.
FFS.
Precisely
Hedge funds as masters of the universe – again. Do some people never learn the lessons of history? Or even read a little analysis? According to the FT (which is trying to put a positive gloss on it) some HF’s have made gains but the article is hedged (sorry) with caveats about many funds profitability, outflows, fees, sector performance and confidence. https://www.ft.com/content/cd928772-f08a-11e7-b220-857e26d1aca4
Capita and Carillion were the most shorted stocks in the UK, it is public information. And the short positions have been held for some time. Did they all have inside information from company? Of course they didn’t. The stockmarket is about opinions and for every seller there is a buyer. Indeed it has been well reported that Neil Woodford (probably the most high profile UK Fund Manager) bought stock on earlier profit warnings as will have other institutions. Indeed profit warnings and stock falls happen every day.
Two things worth remembering you can only short stock if a shareholder “lends” you the stock for which you pay some bp in return. Virtually all major institutions and pension funds lend stock including the Universities Superannuation scheme. If they didn’t then it would be impossible to short. Also who are the investors in hedge funds? Well indirectly it is the general public as Pension funds, Local authorities etc are all big investors into the sector. Also many have retail share classes which are available through platforms such as HL where minimum investments are relatively modest.
I know everyone loves a conspiracy theory but there probably isn’t one here.
Your key word is ‘probably’
Yeah Ben,
Sure thing, whatever. “for every seller there is a buyer” and for every unexplained collapse, shock and scandal there’s a small army of in-the-know excuse makers poking at anecdotes, playing it down and telling everyone that its all perfectly normal.
If this is all “public information” that has been known for some time, as you say, then how did the profit warning get to become a ‘shock’ (the most widely used term) and why did the market behave like it was shock by wiping half the value off the share price in one day?
I have raised an extended question about the massive disconnect between three sets set of players in the same game: the bosses at Capita, the hedge funds and the regular City analysts/traders . That question remains unanswered.
Your attempted answer – that “the stockmarket is about opinions”. Doesn’t cut it. The stockmarket is supposed to be about close interaction among rational, impartial, professionals . To believe you we need to imagine a realm of thoughtless, blowhard gamblers who’ll turn a blind eye to just about anything. That last notion may have some truth but not to this extent. At this level, pretending that it is all quite normal just beggars belief.
As for the suggestion that hedge funds aren’t predominantly exclusive or dominated by high net-worth individuals (directly or “indirectly”) that just beggars belief as well. Citing a few exceptions does not change the rule.
Thanks
Why not ban that sort of hedging? I’m reminded of Bill Mitchell’s words some time ago:
‘From the perspective of Modern Monetary Theory (MMT) there is no question that governments can still use fiscal and monetary policy to pursue public purpose but the real question is why allow an essentially unproductive financial sector to gain access to real income at all.’
He goes on to say that there IS a value to hedging in certain productive fields:
‘Speculation is beneficial because it provides hedgers with opportunities to lay off risks. It also helps to smooth price movements. In the first sense speculation acts like insurance. Speculators become agents who are prepared to bear the risk of unexpected price or interest rate changes while others divest themselves of the risk.
In return the risk-averse parties are prepared to pay the speculators a fee. So a hedger who has an open position may seek to use the forward market.
Speculation also may reduce the amplitude of price movements by pushing down the value of assets that are deemed to over market value and vice versa. Speculators add volume to the market promoting continuous price adjustment and liquidity.
But the mainstream economists underplay the fact that speculation can be destructive because they emphasise rational behaviour. Sometimes investors seem to go mad and get too greedy. In this case, speculative manias driven by herd-like behaviour is destructive to economic activity.’
Isn’t it time for a rethink of all of this? A town near where I live has a huge ‘wealth management fund’ building that is expanding all the time and dominates the centre -what is it really adding to socially useful, productive activity?
Very little in all likelihood Simon
Being busy is noit the same as being productive
Indeed- I occasionally meet people working in this field, many from a maths/physics background-thin of the USEFUL things they could be doing!
I believe they recruit maths/physics people as they can construct and perhaps even understand the complex algorithms banks and other financial institutions use to computerise trades which take place in nano-seconds in response to market movements.
I think Adair Turner described much financial activity as “socially useless”. So let’s have a thorough review and ban many of these activities that are socially useless and economically destructive or inimical to the best interests of the majority of citizens.
Seems to be a few who want to prevent capital markets operating in their current guise and put something else in place. The state controlling the allocation of capital? You really believe that will improve the standard of living of everyone across the piste? How did Eastern Europe fare? There is a good chance things would be less transparent and more corrupt than now. I also really like the term USEFUL.. how about the individual deciding what to do with there talents, how self righteous of someone to say otherwise.
No one is saying that the apical markets will cease to exist. Politely, stop being silly
But if you really think capital markets are efficient and work for the benefit of society as a whole, politely, stop being silly. The evidence that they do not is overwhelming. The costs they impose are staggering. And the state has a duty to correct market imperfection. Making sure capital gets to where it is needed is a way of doing that
Dc
By now I think that everyone is a aware of Godwin’s Law and the logic behind it. This whole technique of defending the indefensible by creating a strawman alternative and expecting others to believe that is only their only remaining option, that is every bit as dishonest as it is passe.
No one else said anything about Eastern Europe, North Korea, Zimbabwe, Stalin or Hitler. Nor would they have any logical reason to do so. Furthermore the suggestion that Simon’s observation is “self-righteous” is merely an unsupported assertion on your part. If talent being is lost to the casino of fictional capital then the idea of making the casino less attractive, or the alternatives more attractive, may have some merit.
Allowing Carillon and Capita to go under is probably less destructive than propping them up with even more taxpayers’ money.
Probably.
Am I advocating for an economic analogy of syphilis being better than cancer?
There is no excuse for propping up these companies because their contracts could be better done in house
All of the disability ‘assessments’ that Capita conduct, for gain, with the clandestine objective of depriving disabled people of support, will be put on hold when they go under; and some of the most vulnerable people in society will be left destitute ‘pending reassessment’ indefinitely.
This is indeed what *should* happen.
If, at any point, you find yourself overwhelmed by cynicism, pessimism, and an inability to tface the world as it is, ask yourself: “What would Jeremy Hunt do?”
At such moments in the day, I find tgat I have been doodling sketches of the gallows and I am – inexplicably – cheered up.
“Capita contract probed after thousands of clinical letters stuffed in a drawer somewhere.
It was not contractually obliged to forward them so…”
https://www.theregister.co.uk/2018/02/02/spending_watchdog_probes_clinical_correspondence_backlog_in_capita_contract/
All that has to have a human cost somewhere. Unless humans are superfluous now…