Competition in mixed markets:
ensuring competitive neutrality
A working paper
July 2010
OFT1242
© Crown copyright 2010
This publication (excluding the OFT logo) may be reproduced free of charge in
any format or medium provided that it is reproduced accurately and not used in
a misleading context. The material must be acknowledged as crown copyright
and the title of the publication specified.
CONTENTS
Chapter/Annexe
Page
1 Executive summary
4
2 Introduction
7
3 What do we mean by competitive neutrality?
10
4 Why does competitive neutrality matter?
14
5 What are the barriers to competitive neutrality?
19
6 What can we do to address these constraints?
26
7 Creating mixed markets
39
8 Areas for further work
44
1
EXECUTIVE SUMMARY
1.1
Over the past decade there has been a rise in the number of mixed
markets, by which we mean markets where state-owned enterprises,
private firms and third sector organisations compete alongside one
another. This paper is a response to the increase in mixed market
provision and is designed for policy makers who are thinking about, or
involved in, creating mixed markets.
1.2
In particular, this paper addresses the issue of competitive neutrality.
Competitive neutrality is the principle that there should be a 'level
playing field' between state-owned enterprises, private firms and third
sector organisations in mixed markets.
1.3
The paper does not consider the issue of whether public bodies should
be privatised or previously public markets should be opened up to
competition. We have taken the market ownership structure as given
and make no judgement on how it might be changed.
1.4
There could be a number of reasons for mixed market provision. In some
cases, such as in health and education, previously public sector markets
are being deliberately opened up to greater provision by private and third
sector providers in an attempt to increase efficiency and/or deliver better
products or services. In other sectors state-owned enterprises are trying
to explore commercial opportunities, competing alongside existing
private firm and third sector organisations. In each of these cases, the
different objectives and approaches of state-owned enterprises, private
firms and third sector organisations can be beneficial for consumers.
Competitive neutrality is not about trying to remove these differences.
1.5
However, where competitive differences do not reflect underlying
differences in costs or objectives – such as where regulations or taxes
apply differently to private, public and third sector providers – then there
is a risk that the market will not operate effectively due to resources
being used inefficiently. This could potentially lead to higher prices and
reduced value for taxpayers.
OFT1242 | 4
1.6
Competitive neutrality is not only about potential disadvantages faced by
the private and third sector when they compete against state-owned
enterprises. While an absence of competitive neutrality can sometimes
disadvantage the private sector, equally there are some cases where the
public sector or third sector is at a disadvantage.
1.7
Competitive neutrality is a minimum condition for setting up effective
mixed markets – ensuring that there are no artificial barriers to entry and
that outcomes are efficient, given wider policy objectives.
1.8
The main barriers to competitive neutrality include:
•
differences in regulation, taxation, and pensions treatment between
different types of providers
•
incumbency advantages enjoyed by existing firms, such as access to
information, pre-qualification and bid criteria, and transition costs,
and
•
1.9
lack of clarity in the application of competition law.
Previous discussions both in the UK and internationally have considered
how to achieve competitive neutrality in mixed markets. This debate
suggests a range of different approaches, including:
•
Making sure public procurers compare bids on a like for like basis.
Many public services are procured by public agencies on behalf of
users, and increasingly this procurement involves buying from mixed
markets. It is important that public procurement reflects and corrects
for differences between bidders that do not relate to true differences
in costs or objectives between firms. More radically, some of the
tax, pension and regulatory differences in treatment between stateowned enterprises, private firms and third sector organisations might
be addressed directly. However, we recognise that wider policy
objectives would need to be taken into account.
•
Ensuring good corporate governance for state-owned bodies that
compete in mixed markets. This can help ensure that commercial
OFT1242 | 5
activities of state-owned enterprises are properly defined and
distinguished from other activities.
•
Application of competition rules to the behaviour of state-owned
enterprises, private firms and third sector organisations regardless of
ownership – ensuring that markets are opened up appropriately to
competition.
•
Overarching competitive neutrality principles to guide public sector
behaviour in mixed markets. The clearest example of this is in
Australia.
1.10
The UK has adopted several of these approaches. As discussed in this
paper, there are good examples of public procurement practices which
attempt to ensure competitive neutrality. The UK also has some
corporate governance measures in place across mixed markets to
encourage competitive neutrality.
1.11
There is however currently limited consistency in the application of
competitive neutrality approaches by different parts of the UK
Government. At a minimum there should be opportunities to share best
practice between departments. The sharing of information would allow
departments to learn from one another's experiences and would mean
that if new mixed markets are created, this could be done in a way that
ensures that the best provider of the good or service is chosen, based on
an equal evaluation between potential providers.
1.12
There may be advantages in developing some overarching competitive
neutrality principles to be followed across the public sector. This would
give a clear sense as to the benefits of competitive neutrality and
provide a clearer framework within which to design sector-specific
approaches.
1.13
The UK Government should also aim to evaluate its different approaches
to competitive neutrality to see whether these have delivered better
outcomes. This would ensure that any principles adopted across the
public sector are grounded on a strong evidence base.
OFT1242 | 6
2
INTRODUCTION
2.1
This working paper is intended to summarise the current debate around
competitive neutrality, particularly as it applies in the UK. It is not a
market study, and has been conducted primarily using publicly available
information and by speaking to a number of stakeholders.
2.2
Competitive neutrality has been an increasing topic of policy debate over
the last five years or so. While the concept has been used in other
countries for some time – most notably in the Australian National
Competition Policy, which established competitive neutrality as a key
principle – the recent discussion in the UK was arguably begun by the
CBI paper A fair field and no favours.1 This summarised the possible
reasons for lack of neutrality between public, private and third sector
competitors, particularly in the context of public sector procurement. It
also drew on evidence from a number of sectors in the UK, such as
health and prison services.
2.3
The Government subsequently considered competitive neutrality as part
of the Julius Review of the public services industry (PSI)2 ('The Julius
Review').3 This found a lack of competitive neutrality in some public
service markets, and argued that differences between different types of
1
Sturgess, G, 2006, A fair field and no favours, Competitive neutrality in UK public service
markets, the Serco Institute & CBI. Available at:
www.serco.com/Images/Comp%20Neutrality_Prf6_tcm3-11584.pdf
2
The Julius Review defined the public services industry to include: 'All private and third sector
enterprises that provide services to the public on behalf of Government or to the Government
itself', p i, BERR, 2008, Public services industry review; Understanding the Public Services
Industry: How big, how good, where next? A review by Dr. DeAnne Julius CBE. Available at
www.berr.gov.uk/files/file46965.pdf
3
BERR, 2008, Public services industry review; Understanding the Public Services Industry: How
big, how good, where next? A review by Dr. DeAnne Julius CBE. Available at
www.berr.gov.uk/files/file46965.pdf
OFT1242 | 7
providers created by Government policies or actions act as a barrier to
effective competition.
2.4
2.5
The OFT has previously looked at competitive neutrality issues in the
context of two market studies:
•
The 2004 study on public sector procurement noted that best value
principles require public and private bidders to compete on an equal
basis and that a local authority must demonstrate that a public
supplier 'offers as good as or better value than a private sector
supplier. However, some suppliers have expressed concerns that
when competing for a contract where a direct service organisation
(DSO) [public provider] is present they are not competing on a level
playing field. For example, suppliers have argued that local
authorities sometimes set very short contract lengths to provide the
DSO with a competitive advantage'4
•
The 2006 study on commercial use of public information considered
one specific example of the interaction between publicly owned firms
and competition. Where public firms collect valuable information
which could be used commercially, the OFT found that there was an
economic benefit in making more of that information available for
commercial use.5
The motivation for this paper is to draw together the current evidence on
competitive neutrality across sectors, and look at possible ways of
addressing any restrictions. It also fills a gap in the OFT's understanding
of the interaction between private firms, third sector bodies and state-
4
Short contract lengths does not allow supplier to recover their initial sunk costs. See
paragraphs 3.33 and 3.34, OFT, 2006, More competition, less waste: Public procurement and
competition in the municipal waste management sector. Available at:
www.oft.gov.uk/shared_oft/reports/comp_policy/oft841.pdf
5
OFT, 2006, The commercial use of public information (CUPI). Available at:
www.oft.gov.uk/shared_oft/reports/consumer_protection/oft861.pdf
OFT1242 | 8
owned enterprises, which was identified as important in our recent
Government in Markets paper.6
2.6
The paper is structured as follows:
•
Chapter 3 explains what is meant by the term 'competitive
neutrality'.
•
Chapter 4 outlines why competitive neutrality is important in terms
of market outcomes.
•
Chapter 5 summarises some of the possible barriers to achieving
competitive neutrality.
•
Chapter 6 outlines the way in which these barriers might be tackled,
and includes examples from the UK and other countries where
different approaches have been attempted.
•
Chapter 7 briefly looks at the issues raised where Government is
opening up new markets to competition (as opposed to those where
mixed markets are already established).
•
Chapter 8 sets out possible ways forward to achieve increased
competitive neutrality in the UK.
6
OFT, 2009, Government in markets. Available at
www.oft.gov.uk/shared_oft/business_leaflets/general/OFT1113.pdf
OFT1242 | 9
3
WHAT DO WE MEAN BY COMPETITIVE NEUTRALITY?
3.1
The defining characteristic of competitive neutrality is that no firm
should have a competitive advantage in a mixed market purely as a
result of its ownership or control. Where state-owned enterprises,
private firms and third sector organisations might be competing
alongside each other, competition should not be affected by ownership.
3.2
In the Government in markets7 paper the OFT set out ways in which
Government has an influence on markets throughout the economy.
Government participates in markets directly and indirectly: direct
participation occurs when Government acts as a supplier or a buyer of
goods and services. Indirect participation is achieved through the use of
taxes, subsidies, regulation and influence, for example, information
campaigns.
3.3
Competitive neutrality issues arise in two main contexts. First, in some
markets, sate-owned enterprises and/or third sector providers compete
to supply final consumers directly alongside the private sector. This
situation can be described as 'competition in the market'8. For example,
some markets which were previously dominated by state monopolies
have been opened up to competition. In these markets private, public
and third sector providers compete to supply consumers. An example of
this type of market is the provision of health care services where private
and third sector hospitals directly compete with NHS hospitals for
publicly funded patients. The OFT's recent report on choice and
competition in public services addresses the issue competition in the
market in areas such as health and education.9
7
Ibid
8
Competition in the market can be defined as how firms already in a particular market compete
on a day to day basis to gain market share.
9
OFT, 2010, Choice and Competition in Public Services: a guide for policy makers, A report
prepared for the OFT by Frontier Economics. Available at
www.oft.gov.uk/shared_oft/business_leaflets/general/oft1214.pdf
OFT1242 | 10
Figure 1: 'Competition in the market'
Public agency
third and private sector providers
Consumer
3.4
In other cases, public procurement takes place on behalf of final
consumers. This can be described as 'competition for the market'.10
When the Government uses procurement to supply services it can
frequently buy those services from private or third sector providers as
well as in-house publicly owned bidders. Refuse collection is an example
where the Government purchases goods and services from the private
sector firms. In some cases there is also a Government supplier which
competes with other suppliers, for example in the case of prisons.
Figure 2: 'Competition for the market'
Public agency
third and private sector providers
Competitive
Tendering
Government
Consumer
3.5
10
Competitive neutrality does not mean that no firms can enjoy a
competitive advantage. Competitive advantages can occur for a number
of reasons, for example as a result of the size of the business. Large
blue-chip companies will be able to borrow money at a lower interest
rate than a small firm which has recently started operations. This
difference in the cost of borrowing reflects the expected risk of a firm
'Competition for the market' can be defined as how firms initially compete to supply a market
OFT1242 | 11
failing and is not related to competitive neutrality. Competitive
advantages can exist at the same time as competitive neutrality. For
example, it is possible for there to be competitive neutrality and for a
particular firm to still have lower costs because of more efficient
production techniques.
3.6
Competitive advantage helps drive the dynamic competitive process
which means that more efficient firms expand and do well while
inefficient firms lose customers and leave the market. The danger is that
a lack of competitive neutrality artificially distorts these competitive
dynamics and means that markets do not work as well as they might.
This will result in some inefficient firms remaining in the market and
some more efficient firms being unable to grow and innovate effectively.
This inefficiency may lead to lower quality and higher prices for
consumers and also to lower levels of innovation in the sector as a
whole than would otherwise have been the case.
3.7
When considering competitive neutrality, we are interested in differences
in costs or other parameters of competition which stem solely from
differences in ownership or control. These might include, for example,
differences in regulation, tax treatment, or public service obligations.
3.8
Though competitive neutrality most often concerns the advantages
enjoyed by public undertakings, the principle is just as applicable to their
disadvantages. These competitive disadvantages might include: greater
accountability obligations, requirement to provide universal service
obligations, reduced managerial autonomy, requirements to comply with
Government wages, employment and industrial relations policies, and
higher superannuation costs.11 These conditions and obligations are
generally imposed by Government in the interests of achieving wider
policy aims, and it is for Government to balance those aims against any
potential for distortion of the market in question.
11
Taken from Hilmer, F, 1993, National competition policy (the Hilmer report). Available at:
ncp.ncc.gov.au/docs/Hilmer-001.pdf
OFT1242 | 12
3.9
In any particular case it is likely to be difficult to determine whether the
public body enjoys a net advantage or disadvantage. See Box 1 for an
example of a market where the public operator suffers both competitive
advantage and disadvantage.
Box 1 Liberalisation of the UK postal market
Liberalisation of the European postal market has allowed private mail companies
such as TNT and Deutsche Post to enter the UK market in competition with the
previous state monopolist, Royal Mail. While Royal Mail enjoys exemption from
VAT12, it suffers from a competitive disadvantage because it is required to offer
a universal delivery service for a single price while new entrants to the market
can chose which services to provide, for example, parcel delivery, based on
expected profitability. We make no comment on whether these advantages and
disadvantages are 'right' or 'wrong', but we use them simply to illustrate the
difficulty that can arise when trying to assess whether a public body enjoys a
net competitive advantage or disadvantage as a result of its ownership.
12
TNT Post NV, a competitor to Royal Mail for mail services, challenged the UK's position on
VAT in the High Court. This was referred by the High Court to the European Court of Justice
(ECJ). TNT Post argued that, where the market is liberalised, VAT should be charged on all
services to avoid market distortion. The ECJ upheld Royal Mail's exemption for universal postal
services but concluded that it does not apply where Royal Mail's services are provided at
individually negotiated prices. As a result, some postal services as supplied by Royal Mail, such
as those that are individually negotiated or not subject to any price and regulatory control, which
have been treated as exempt, will become liable to VAT. HM Revenue & Customs are currently
in discussions with Royal Mail to establish precisely which of their services will be affected and
further guidance will be issued once these discussions are complete.
OFT1242 | 13
4
WHY DOES COMPETITIVE NEUTRALITY MATTER?
4.1
Competitive neutrality is important because it affects the efficiency of
mixed markets and firms' incentives to innovate. Public service markets
(PSI) are large markets: the Julius Review estimated that in 2007/8
Public Service Industries (PSI) revenues were £79bn, generating £45bn
in value added and employing over 1.2 million people. Health represented
about a third of the total value followed by social protection (22 per
cent), defence (12 per cent) and education (nine per cent) - since 1996
the PSI has as grown almost 130 per cent as a result of Government
policy to increase the role of mixed markets in the economy.13
4.2
A lack of competitive neutrality has short and long-term effects. The
short term direct effect is that contracts are not awarded to the most
efficient providers so resources are allocated inefficiently. Any
inefficiency in the allocation of resources will cause consumer detriment
if it leads to higher prices and less choice than would be available in an
efficient market. It is also likely to mean that taxpayers spend more on
the provision of services than is needed.
4.3
In the long run there is likely to be a reduction in innovation and
development of new, more efficient, production processes because any
advances are offset by the competitive disadvantage faced as a result of
ownership. As noted in our Government in markets report it is important
that competition occurs as openly as possible: 'Where public sector
bodies are engaged in mixed markets alongside private firms, it is
important for the public bodies to ensure that they are not exploiting
unfair advantages over the private sector and stifling innovation or
improved efficiency that private firms may bring to the market.'14
13
p ii, BERR, 2008, Public services industry review; Understanding the Public Services Industry:
How big, how good, where next? A review by Dr. DeAnne Julius CBE. Available at
www.berr.gov.uk/files/file46965.pdf
14
p 42, OFT, 2009, Government in markets. Available at
www.oft.gov.uk/shared_oft/business_leaflets/general/OFT1113.pdf
OFT1242 | 14
4.4
The wider economy benefits from competitive markets because they
encourage greater productivity and innovation and preserve long term
growth while continuing to provide greater value for money to the
taxpayer. Competitive markets are not necessarily private or mixed.
Competitive markets are those where the products or services are
produced as efficiently as possible therefore delivering the best possible
outcome for the consumer, which in some cases is the taxpayer.
Mixed markets
4.5
Since the 1980s some markets that were previously dominated by
publicly-owned monopolies have been opened up to competition from
private and third sector operators. In some UK markets, for example
telecommunications, the state monopolist has been privatised but in
other markets, for example prisons, the public sector still operates.
4.6
In line with many other countries, the UK Government has introduced
mixed markets because it believes 'working in partnership with private
and third sector providers … [ensures] our goals of excellent, fair and
cost effective public services are achieved.'15
The arguments for mixed markets
4.7
Private firms are usually assumed to maximise profit. The incentives for
public and third sector organisations are more complicated: public
operators have a range of incentives depending on the policy objective
they are trying to achieve, for example they may try to maximise
employment or output. Because of the diverse nature of the third sector,
third sector organisations also have a wide range of incentives. These
15
Foreword by John Hutton, BERR, 2008, Public services industry review; Understanding the
Public Services Industry: How big, how good, where next? A review by Dr. DeAnne Julius CBE.
Available at www.berr.gov.uk/files/file46965.pdf
OFT1242 | 15
can be loosely defined as working to maximise their benefit to their
users.16
4.8
These different incentives are likely to mean that different types of
operators will deliver a different outcome even when competitive
neutrality exists. Different types of providers will bring particular skills,
for example private operators may have more streamlined management
processes while third sector operators will have expertise about the
specialist needs of the recipients of the public service.
4.9
Having a public operator in a market can also help provide the
Government with more information about how the market works. Such
information can facilitate more efficient price and quality regulation or
more efficient tendering processes. One of the fundamental issues faced
in the provision of public goods is the asymmetry of information
between the authority commissioning the service and the provider of
that service.
4.10
It is for the Government department commissioning the service to decide
what they want to achieve when they contract out a particular public
service. As noted in De Fraja (2009), 'the ownership of a firm or an
agency will affect its objective, and different objectives will lead to
different behaviours, which in turn might affect differently other firms or
agencies in the industry. However, there is nothing intrinsically 'right' or
'wrong' in having one objective or another.'17
16
Under the Charities Act 2006, charities are required to operate only for the public benefit.
They are required by law to limit their activities to those that are within charities objects and
powers. Charities must also be independent of Government and other funders, trustees must act
only in the interests of the charity and its beneficiaries, and trustees must make decisions in line
with their duty of care and duty to act prudently. Source: p 6, Charity Commission, 2007,
Charities and Public Service Delivery: An introduction and overview. Available at: www.charitycommission.gov.uk/Library/publications/pdfs/cc37text.pdf
17
De Fraja, G, 2009, Mixed oligopoly: old and new. Paper prepared for the Swedish Competition
Authority 2009, Pros and Cons seminar on Pros and Cons of Competition in/by the Public
Sector, held in Stockholm, 13 November 2009.
OFT1242 | 16
The value of competitive neutrality
4.11
Competitive neutrality is important in mixed markets. In many mixed
markets goods and services are purchased by the Government. Good
procurement means getting value for money – that is, buying a product
or service that is fit for purpose, taking account of the whole-life cost.
4.12
In the UK more than £175 billion is spent every year on the goods and
services required to deliver public services.18 The Government's objective
is to achieve the best value for money through running an efficient
procurement process for these goods and services. Value for money
means finding the balance of cost, quality and choice that delivers the
best outcome. The consumers of the product or service depends on the
market in question, in some cases it will be a Government department
and in others it will be members of the public, for example in the
provision of unemployment services.
4.13
Running a competitive procurement process is good for consumers and
the taxpayer because it means the most efficient organisation that
delivers the best outcomes in terms of quality and cost will win the
contract to provide the good or service.
4.14
The main evaluation of the effects of competitive tendering on public
services is contained in the Julius Review: this found that competitive
tendering in PSI markets has brought benefits to the UK economy with
cost savings of between 10 and 30 per cent and no decrease in quality.
The review gave no clear answer about the effects of mixed markets on
consumer welfare. However it did conclude that partnership models19
were usually delivered on time and, when public sector over-runs were
18
p 3, HM Treasury, 2008, Accelerating the SME economic engine: through transparent, simple
and strategic procurement. Available at: www.hm-treasury.gov.uk/glover_review_index.htm
19
'Partnership models' are public-private partnership (PPP) and private finance initiative (PFI)
models.
OFT1242 | 17
included in the comparison, were not more expensive than public
provision.20
4.15
The study found that the economic benefits occurred despite the lack of
competitive neutrality. It may be that if there was increased competitive
neutrality there may be greater benefits derived from competitive tenders
in PSI markets.
20
BERR, 2008, Public services industry review: Understanding the Public Services Industry: How
big, how good, where next? A review by Dr. DeAnne Julius CBE. Available at
www.berr.gov.uk/files/file46965.pdf
OFT1242 | 18
5
WHAT ARE THE BARRIERS TO COMPETITIVE NEUTRALITY?
5.1
There are significant barriers to achieving competitive neutrality in the
UK. Barriers can arise during the direct competition between public,
private and third sector operators or during procurement of goods and
services by the public sector.
5.2
Key barriers to competitive neutrality are:
5.3
•
differences in regulation, pension, and tax treatment between public
private and third sector providers
•
legal application of competition law, and
•
incumbency advantages enjoyed by existing firms, such as access to
information, pre-qualification and bid criteria, and transition costs
In this chapter we briefly consider each of these factors.
Regulation, pensions and tax treatment
5.4
The CBI in their report A fair field and no favours21 identified governance
and regulatory arrangements as a source of competitive non-neutrality in
mixed markets. This includes regulation, taxation, pensions and capital
cost.
Taxation
5.5
Public, private and third sector operators will face different tax treatment
as a result of their ownership structure. These non-discretionary cost
differences can result in significant advantages/disadvantages for firms
competing in mixed markets. For example, Corporation tax is applied to
the profits of private sector operators. Public and third sector operators
21
See A fair field and no favours, Competitive neutrality in UK public service markets, the Serco
Institute & CBI. Available at: www.serco.com/Images/Comp%20Neutrality_Prf6_tcm311584.pdf
OFT1242 | 19
on the other hand are exempt from paying tax on their surplus revenue.
While there are clear reasons for these differences, it can distort firms'
ability to compete on the same basis as not-for-profit organisations and
may reduce private providers' incentive to invest. 22
5.6
The Office of Health Economics in their research on competition
between independent and NHS providers found 'all else being equal, a
Corporation tax paying entity would have to charge higher prices than
would an NHS body or charity to achieve the same return on
investment.' They estimated that Corporation tax can add between 2 per
cent and 4 per cent to the total cost of for profit organisations.23
5.7
Tax rules regarding VAT are also applied differently across public, private
and third sector operators. There is the possibility of tax equivalence
being introduced by central Government departments and agencies
through accounting changes. However, the complexity of VAT rules
means this is likely to require some deliberation. It is also worth noting
that in some markets, for example postal services, UK VAT rules are
affected by the implementation of a European Union (EU) VAT Directive.
Any change of these rules would seem to require a change to the VAT
Directive, which would require unanimous approval of all EU member
states.
Pensions
5.8
Public providers do not have to explicitly recognise pension costs on
their balance sheets when bidding for public sector contracts whereas
private and third sector providers do. This can give public sector bid
teams an advantage due to the different treatment they receive.
22
'How Fair? Competition between independent and NHS providers to supply non-emergency
hospital care to NHS patients in England' by the Office of Health Economics provides a detailed
discussion of the effects of corporation tax.
23
ibid
OFT1242 | 20
5.9
In the debate about competitive neutrality the issue of pensions is
frequently mentioned. In the report Counting the cost; Full cost
comparison between public service providers the CBI specifically
highlights public sector pension costs as a 'major barrier to a level
playing field in public service markets and therefore to market entry for
providers in a number of sectors.'24 The Ministry of Justice explicitly
recognised the issue of public sector pension in its recent procurement
process. See Box 3 on page 26 for more details.
Cost of capital
5.10
Public sector operators will typically be able to borrow capital at a
preferential rate compared with private and third sector providers. This
reflects private lenders' expectation that the taxpayer will 'bail out'
public sector operators.25
5.11
Where mixed markets exist, differences in the cost of capital can be a
significant barrier to entry, particularly where the provider is small
relative to the investment they are required to make to enter the market.
Advantages for public sector operators
5.12
The CBI also identified a number of sources that specifically relate to
competitive advantages enjoyed by publicly owned enterprises:26
24
p 4, Walker, D, 2008, Counting the cost; Full cost comparison between public service
providers, CBI. Available at: www.cbi.org.uk/pdf/CBICompetitiveNeutralitybrief.pdf
25
This issue was cover in 'Northern Rock: The impact of public support on competition' OFT
2009 Available at www.oft.gov.uk/OFTwork/markets-work/completed/northern-rock
26
Although listed in the CBI's report the original list was developed by the OECD. p 5, Sturgess,
G, 2006, A fair field and no favours, Competitive neutrality in UK public service markets, the
Serco Institute & CBI. Available at: www.serco.com/Images/Comp%20Neutrality_Prf6_tcm311584.pdf
OFT1242 | 21
•
Subsidies from Government to fund public service obligations, if used
to cross-subsidise commercial activities. Such subsidies could create
an advantage for the public operator if it means they have access to
lower costs for their commercial activities as a result.
•
Access to date collected for public purposes, where the public sector
entity can use that data on terms more favourable than those
available to the private sector. This issue was highlighted in the
OFT's market study looking at the commercial use of public
information (CUPI).27 In the study the OFT considered the barriers
facing private operators trying to access public information. One of
the findings of the study was that much of the legislation and
guidance that aims to provide for equal access to public information
lacks clarity and is inadequately monitored.
Legal application of competition law
5.13
In principle the competition rules governing anti-competitive agreements
and abuse of dominance apply to both privately and publicly owned
enterprises equally wherever a public body is acting as an 'undertaking'.
In practice, applying competition law to public bodies can be difficult
where there is doubt as to whether, and in what circumstances, they are
acting as 'undertaking' and therefore subject to competition law.
5.14
Some of the complexities involved in applying competition law to public
bodies are illustrated in BetterCare Group v Director General of Fair
Trading28 which is discussed in Box 2 below.
27
OFT, 2006, The commercial use of public information (CUPI). Available at:
www.oft.gov.uk/shared_oft/reports/consumer_protection/oft861.pdf
28
Case No 1006/2/1/01 [2002] CAT 7, [2002] CompAR 299
OFT1242 | 22
Box 2: BetterCare
The OFT received a complaint from BetterCare Group Ltd (BetterCare), a UK
provider of residential and nursing care that a UK Health and Social Services
Trust had abused its dominant position by offering unfairly low prices and unfair
terms in its purchases of social care from BetterCare. The Trust provided
residential and nursing care to the elderly both directly and through a private
contractor. Whilst the Trust charged for its services, it did not recover its costs
in full.
The OFT considered that the Trust was not an undertaking for the purposes of
the Competition Act 1998 when engaging in purchasing activity. On appeal to
the UK Competition Appeals Tribunal (CAT) in BetterCare II the CAT29 held that
the Trust was acting as an undertaking, both in the purchasing of services from
BetterCare as well as in the direct provision of elderly care. 30 The CAT's
reasoning was that, in deciding whether the activity was economic in character,
a key consideration was whether an entity is in a position to generate the
effects which the competition rules seek to prevent.31
However, the subsequent judgments of the Court of First Instance (CFI) and
European Court of Justice (ECJ) do not follow the same reasoning as the CAT in
BetterCare II. In FENIN v Commission the Courts concluded that the nature of
the purchasing activity had to be determined according to whether or not the
subsequent use of the purchased goods is an economic activity.32 The CFI
considered that where an organisation purchases goods, not for the purpose of
offering goods and services as part of an economic activity, but in order to use
them in the context of a different activity, such as an activity of a purely social
29
At that time called the Competition Commission Appeal Tribunal or CCAT.
30
Paragraphs 191-194, Case No 1006/2/1/01 [2002] CAT 7, [2002] CompAR 299
31
Ibid paragraph 190.
32
Paragraph 36, Case T-319/99 FENIN v Commission
OFT1242 | 23
nature, then it is not acting as an undertaking simply because it is a purchaser
of those goods. This judgment was upheld on appeal to the ECJ.33
There will only be further clarification on the scope of the application of the
competition rules to state organisations through additional case law.
Incumbency Advantages
5.15
One of the largest sources of competitive non-neutrality relates to the
advantages enjoyed by incumbent suppliers during the procurement for
contract. Although, incumbency advantage is often concerned with the
advantages enjoyed by public sector operators, it is equally applicable to
the private or third sector. Incumbency advantages can occur in any
industry that is moving from a monopoly/dominant operator provision to
competitive tendering. This is not unique to mixed markets but is
particularly prevalent because of the shift from in-house provision of
services by government to outsourcing.
5.16
The Julius Review highlighted the following areas where there may be
concerns during the procurement process resulting from incumbency
advantages:
33
•
Pre-qualification / bid criteria: In many cases Government demands
that bidders have a demonstrable history in the area; this is to ensure
bidders have appropriate expertise. This can, however, limit the
ability of new entrants to break into markets.
•
Lack of shared information: Where there is a lack of information on
current service levels or the costs involved, incumbents are likely to
have an advantage over other bidders.
•
Transition costs: If a different bidder wins a contract they may face
start-up or transition costs. Where these are likely to be significant,
Paragraphs 25-26, Case C-205/03 P [2006] ECR I-6295, [2006] 5 CMLR 559
OFT1242 | 24
they could outweigh other cost advantages and thereby limit
competition.
5.17
It may be possible for Government to overcome barriers in the
procurement process. One example of a Government department's
attempts to encourage competition is HM Revenue & Customs' (HMRC)
actions during the tendering of IT services. In its 2004 procurement of
the £3 billion IT outsourcing contract, ASPIRE, HMRC contributed to
firms' costs of bidding, paying the winner's costs in taking over from the
existing supplier (a private operator), discounting the transition costs for
the purposes of comparing bids and paying the incumbent supplier to
effect the transfer. This was all to encourage competition for the very
large contract (approximately £3.8 billion). Compared to the total value
of the ASPIRE contract the £75 million spent on costs of procurement
and transition were small, about two per cent of the projected value of
the contract.
5.18
In the National Audit Office's (NAO's) value for money report looking at
the procurement, the transition and the initial performance of the
contract, the NAO judged that HMRC was successful in completing the
first major re-competition of a large public sector IT contract and that
there was justification in this case for using incentives to encourage
competition. The NAO also concluded that HMRC considered that not to
pay these costs would send out a wider signal to the market that the
department was effectively locked-in to the incumbent supplier because
the costs of transition would make the competition unwinnable for any
supplier other than the incumbent.34
5.19
Chapter 6 outlines further ways in which competitive neutrality could be
achieved.
34
NAO, 2006, HM Revenue & Customs: ASPIRE - the re-competition of outsourced IT services.
Available at: www.nao.org.uk/publications/0506/hm_revenue_and_customs_aspire.aspx
OFT1242 | 25
6
WHAT CAN WE DO TO ADDRESS THESE CONSTRAINTS?
6.1
There are a number of ways of achieving competitive neutrality. These
include:
•
Reviewing differences in regulation, tax, and pension between
different types of operator.
•
Ensuring that public procurement takes place on a competitively
neutral basis. This may include improving existing guidance on
procurement.
•
Appropriate corporate governance for state-owned enterprises.
•
Introducing overarching competitive neutrality principles or
framework.
Current UK Government approach
6.2
Some UK Government departments have tried consciously to tackle the
issue of competitive neutrality. The Ministry of Justice (MoJ) and
Department for Work and Pensions (DWP) have taken a number of steps
to try and ensure that procurement is carried out in an efficient manner.
The Department of Health (DH) has also taken steps to try and ensure
that competition between the NHS and private and third sector
organisations operates fairly.
6.3
The National Offender Management Service (NOMS): the original remit of
NOMS expressly stated that it intended to commission services from the
best provider. In recent MoJ contracts for custodial services there were
Principles of competition which set out ways in which competitive
neutrality concerns would be addressed in the procurement process.
More details are given in Box 3.
Box 3: Prisons
In November 2009 the Ministry of Justice announced a competition to operate
custodial services at HMP Birmingham, HMP Buckley Hall, HMP & YOI
OFT1242 | 26
Doncaster and HMP Featherstone II. In addition a contract was announced to
operate custodial services at HMP Wellingborough with the potential to upgrade
the facilities at the prison. The competition for these contracts will be assessed
in line with the Principles of competition (the Principles). These Principles were
developed after consultation with stakeholders and designed to remove any
advantages that apply to particular bidders as a result of their ownership. We
now briefly outline the main Principles.
Process: The MoJ has separated its regulatory, commissioning, procurement and
bidding functions into different departments to try to avoid any conflicts of
interest that arise when assessing public, private and third sector bids. The MoJ
also aims to provide all relevant information in a timely manner to try and reduce
any incumbency advantages.
Costing: A formula is given which must be applied to all public sector bids to
reflect the allocation of indirect costs. Transition, contract administration and
monitoring costs will not be allocated to any bid unless they are additional costs
arising because of a particularly novel approach in one bid.
Grant funding: All bidders must declare any grant funding, including any
received by subcontractors. Bidders must attest that any grant will not be used
to subsidise their bid, including indirect costs.
Pensions: Information is given about the Cabinet Office's Statement of Practice
on Staff Transfers in the Public Sector (COSOP). COSOP addresses pensions
and provides guidance on the broader issue of the treatment of staff who are
transferred from the public sector. Where there is a public sector incumbent, all
public sector bids must apply an uplift of three per cent per annum to all payroll
costs.
Risk: A list of risks which are considered insurable is given and the principles
require that each bid includes a limit of liability for each of the listed risks
irrespective of bidder type. Any public sector bidder is required to obtain a quote
for commercial insurance cover. Bidders must identify all other risks contingent
on the contract and clearly attribute their true commercial value. These risks
include: contractor performance, asset and property maintenance risks and
pension costs and liabilities. If a part of the service does not meet the service
OFT1242 | 27
level stated in the contracts the contractor will incur a penalty, while a public
sector bidder may not ultimately be subject to such financial deductions, their
bid shall be evaluated as if these deductions were to apply.
Tax: Special mention is made of VAT and Corporation tax (CT) and the different
liabilities faced by different bidders. The evaluation of bids will exclude VAT and
CT although bidders are required to provide details of expected liabilities for
both.
6.4
The Department of Health's 2007 commissioning framework is designed
to promote 'a stronger focus on commissioning the services and
interventions that will achieve better health, across health and local
Government, with everyone working together to promote inclusion and
tackle health inequalities.'35 This framework is currently being rewritten.
The NHS's Principles and rules for cooperation and competition
document,36 issued in December 2007, set out fair competition rules for
primary care trusts to apply to all providers. Competitive neutrality is
recognised in the principles which state that 'commissioners should
commission services from the providers who are best placed to deliver
the needs of their patients and population.'37 In January 2009 the
Cooperation and Competition Panel (CCP) was launched. The CCP helps
ensure that the principles and rules are followed and investigates
potential breaches.
6.5
The Department for Work & Pensions (DWP) uses a 'prime contractor'
model where there is one main contractor who has direct contact with
35
p 10, Department of Health, 2007, Commissioning framework for health and well-being.
Available at:
www.dh.gov.uk/en/publicationsandstatistics/publications/publicationspolicyandguidance/DH_072
604
36
NHS, 2007, Principles and rules for cooperation and competition. Available at:
www.ccpanel.org.uk/content/Principle-and-rules-for-Cooperation-and-Competition.pdf
37
p 4, NHS, 2007, Principles and rules for cooperation and competition. Available at:
www.ccpanel.org.uk/content/Principle-and-rules-for-Cooperation-and-Competition.pdf
OFT1242 | 28
DWP and then subcontracts out various parts of the contract. The level
of subcontracting differs between prime contractors. After consulting
with potential providers from all sectors DWP published a Commissioning
Strategy38 in February 2008. While this Strategy does not have a distinct
competitive neutrality section, it does describe best practice with regard
to treatment of sub-contractors and other partners or suppliers, including
recognition of third sector requirements, and gives principles of
behaviour between providers.
6.6
As far as we are aware, there has so far been little work to evaluate
whether these different competitive neutrality approaches have been
successful in helping deliver better outcomes. There may be benefits in
implementing measures to evaluate these.
Procurement guidance
6.7
Good procurement means getting value for money – that is, buying a
product or service that is fit for purpose, taking account of the whole-life
cost.
6.8
The Government has recognised how important good procurement is,
and issued a range of guidance about how a successful tendering
process can be run. For example, HM Treasury (HMT) has issued
guidance about methods for running successful procurement processes,
and the Office of Government Commerce (OGC) was established to help
Government achieve value for money.
6.9
There are also some general principles which help deliver successful
procurement in most cases.39 These principles have been adopted by
some central Government departments. For example the Communities
38
DWP, 2008, DWP Commissioning Strategy. Available at: www.dwp.gov.uk/docs/cs-rep08.pdf
39
The principles are given in HM Treasury, 2007, Transforming government procurement.
Available at: www.supply2.gov.uk/pdfs/transforming_government_procurement.pdf
OFT1242 | 29
and Local Government (CLG) National Procurement Strategy for the Fire
and Rescue Service 2008 – 2011 consultation paper incorporates the
principles.40
6.10
The third sector faces specific barriers to entry when it is considering
bidding for public contracts. This is primarily due to their scale and lack
of expertise in bidding for public contracts. To try and address these
concerns in 1998 the 'Compact on Relations between Government and
the Voluntary and Community Sector in England' ('the Compact') was
introduced. This is a framework agreement for how the Government and
the third sector should work together and is designed to improve the
relationship between the two.41
6.11
Competitive neutrality during the procurement process is important to
ensure the best outcome is achieved. The way procurement is managed
can also have a substantial impact on competition in the market. This is
examined in more detail in the OFT's Assessing the impact of public
sector procurement on competition.42
Corporate governance for publicly owned organisations
6.12
Another way of encouraging competitive neutrality is to have corporate
governance measures which ensure that publicly owned bodies operate
in a way that does not unnecessarily distort the market. In many cases
40
Paragraph 2.3.26, CLG, 2008, The National Procurement Strategy for the Fire and Rescue
Service 2008 – 2011, Consultation. Available at:
www.communities.gov.uk/documents/fire/doc/procureconsult.doc
41
The national Compact is underpinned by codes of good practice on: funding and procurement,
consultation and policy appraisal, ethnic minority voluntary and community organisations,
volunteering and community groups. Local Compacts, informed by the national Compact and
Codes, are local level agreements for partnership working between voluntary and community
sector organisations and public sector bodies at the local level. See
www.cabinetoffice.gov.uk/third_sector/compact.aspx for more information.
42
OFT, 2004, Assessing the impact of public sector procurement on competition. Available at:
www.oft.gov.uk/advice_and_resources/resource_base/market-studies/completed/procurement
OFT1242 | 30
publicly owned bodies are run at arms-length from the owner, for
example municipally owned bus operators.43
6.13
Having appropriate corporate governance measures in place is an
important part of having an effective legal and regulatory framework for
state owned enterprises. The OECD has issued guidelines on the
corporate governance of state owned enterprises. The importance of
competitive neutrality is noted in the Foreword as follows: 'another
important challenge is to ensure that there is a level-playing field in
markets where private sector companies can compete with state-owned
enterprises and that Governments do not distort competition in the way
they use their regulatory or supervisory powers.'44
UK
6.14
The UK has a number of bodies that are designed to manage the
Government's involvement in businesses.
6.15
The Shareholder Executive45 manages the Government's shareholding in
UK businesses. The Government currently owns shares in 29 businesses
in varying proportions of total ownership. The Shareholder Executive's
overarching objective is to be an effective shareholder of businesses
owned or part-owned by the Government. It has a number of specific
objectives relating to the businesses it has an interest in.
6.16
Since the banking crisis in 2008 caused the Government to take stakes
in a number of banks, UK Financial Investments (UKFI)46 has managed
43
The 1985 Transport Act required municipal and passenger transport executive (PTE) operators
to be run at arms-length from the local authority
cfit.independent.gov.uk/pubs/2001/ebp/ebp/stage3/a1.htm
44
OECD, 2005, OECD Guidelines on Corporate Governance of State-Owned Enterprises.
Available at: www.oecd.org/dataoecd/46/51/34803211.pdf
45
www.shareholderexecutive.gov.uk
46
www.ukfi.gov.uk
OFT1242 | 31
those shares. UKFI is a Companies Act Company with HM Treasury as
its sole shareholder. The company's activities are governed by its Board,
which is accountable to the Chancellor of the Exchequer and, through
the Chancellor, to Parliament. UKFI's objective is set out on its website
as being 'to protect and create value for the taxpayer as shareholder
with due regard to the maintenance of financial stability and to act in a
way that promotes competition.'47
6.17
6.18
Partnerships UK (PUK)48 is a public private partnership (PPP)49 between
HMT and the private sector which works with the public sector in five
main areas.
•
supporting complex procurement projects
•
developing procurement and investment policies
•
supporting individual infrastructure projects
•
developing public service commissioning models
•
investing in projects and companies
Part of this work involves PUK supporting the market through the
production of guidance and standard forms and governance and
regulatory support through various review processes.
47
www.ukfi.gov.uk/about-us/what-we-do/
48
www.partnershipsuk.org.uk
49
A PPP is an umbrella term for Government schemes involving the private sector in public
sector projects.
OFT1242 | 32
Norway50
6.19
Norway provides an interesting comparison to the UK as the State is an
important owner in the Norwegian economy, primarily due to its
extensive ownership in the largest Norwegian listed companies. The
Ministry of Trade and Industry manages state ownership interests in
more than 80 companies.51 State owned enterprises (SOEs) have a
variety of objectives ranging from commercial objectives to sectoral
policy objectives.
6.20
In its OECD submission, the Norwegian Competition Authority (NCA)
highlights the importance of market participants believing that state
ownership is being performed along similar lines to private operators, for
example clear division of roles between shareholders, management and
the board of directors. In some markets there is more than one SOE
operating. When this occurs it is important that SOEs compete against
each other in a normal manner.
6.21
There is no formal competitive neutrality policy or framework in Norway.
The State does have principles of good corporate governance and
corporate management, which state in particular that:
•
All shareholders shall receive equal treatment.
•
There shall be transparency in State ownership of companies.
•
Ownership decisions/ resolutions shall be taken/ adopted at the
annual general meeting.
50
Information in this section taken from Norway's OECD submission to Working Party 3 on Cooperation and enforcement Discussion on corporate governance and the principle of competitive
neutrality for state-owned enterprises
51
www.regjeringen.no/en/dep/nhd/selected-topics/ownership/State-Ownership/the-organisationof-state-ownership.html?id=448425
OFT1242 | 33
6.22
52
•
The State, in cooperation with other owners when relevant, shall set
performance targets for the companies: the boards shall be
responsible for achieving these targets.
•
The composition of the board shall be characterised by competence,
capacity and diversity, and reflect the distinctive characteristics of
the company.
•
Wage and incentive schemes shall be formulated so that they
promote value creation in the companies and are perceived as
reasonable.
•
On behalf of the owners, the board shall exercise independent
control of the company management.
•
The board shall adopt a plan for its own activities and work actively
to develop its own competencies.
•
The company shall be aware of its responsibilities to society at
large.52
The NCA has two methods available to raise and follow-up on any
concerns about competitive neutrality. First, it can intervene by
regulation against terms of business, agreements or actions that restrict
or are liable to restrict competition contrary to the purpose of the
Norwegian Competition Act. In addition the NCA can also call attention
to any restrictive effects on competition of public measures and, where
appropriate, submit proposals aimed at furthering competition and
facilitating market access by new competitors. Since 2004 the NCA has
been able to oblige the relevant Government authority to provide a
response to their concerns within a specified deadline.
www.eierberetningen.nhd.no/index.gan?id=1427&subsid=0.
OFT1242 | 34
Overarching competitive neutrality framework
6.23
One of the simplest ways of ensuring competitive neutrality is to have
an overarching competitive neutrality framework that applies to all
Government owned operators, as is the case in Australia. It is worth
noting that Australia is the only country we have found with a
competitive neutrality framework and that having a framework is not
necessary to achieve competitive neutrality. For example, Spain has
stopped short of introducing a competitive neutrality framework.
However they do have specific provisions which aim to reinforce
competitive neutrality in the markets where public enterprises are active
(see paragraph 6.28 for more details).
Australia
6.24
In 1992 the Australian Governments commissioned the Independent
Committee of Inquiry into a National Competition Policy (Hilmer Report),
which reported in 1993.53 In 1995, leaders of Governments signed the
three agreements (Competition Principles Agreement (CPA),54 Conduct
Code Agreement55 and Agreement to implement the National
Competition Policy and Related Reforms56) in which they committed to a
programme of economic reforms. This programme was known as the
National Competition Policy (NCP). Clause 3 of the CPA encourages the
Governments to pursue competitive neutrality.
53
Hilmer, F, 1993, National competition policy (the Hilmer report). Available at:
ncp.ncc.gov.au/docs/Hilmer-001.pdf
54
ncp.ncc.gov.au/docs/cpa%20amended%202007.pdf
55
ncp.ncc.gov.au/docs/Conduct%20Code%20Agreement%20amended.pdf
56
ncp.ncc.gov.au/docs/Agreement%20to%20Implement%20the%20NCP%20and%20Related%2
0Reforms.pdf
OFT1242 | 35
6.25
The suggested means of achieving competitive neutrality is through
corporatising significant Government business enterprises.
Corporatisation means that state assets or entities are converted to state
owned corporations in order to introduce corporate management
techniques to their administration.57 One of the effects of corporatisation
is that the state owned corporation now faces taxes, or tax equivalents,
debt guarantee fees and regulations similar to those facing the private
sector.
6.26
It is interesting to note that while competitive tendering and contracting
is not required under the CPA, a discussion paper about competitive
neutrality notes that competitive tendering can complement the delivery
of competitive neutrality outcomes.58 The same paper notes that an
effective competitive neutrality policy can contribute significantly to
confidence in the fairness of a Government's competitive tendering and
contracting when Government businesses are allowed to bid for
Government tenders.
6.27
There has been no specific evaluation of the effect of the competitive
neutrality requirements contained in the CPA. There has been some
evaluation of the NCP regime; a 2005 inquiry by the Australian
Productivity Commission59 found that the NCP delivered substantial
benefits to the Australian community which, overall, have greatly
outweighed the costs. The benefits were found to be a contribution to
an increase in productivity, reduced prices of goods and services such as
electricity and milk, stimulated business innovation, customer
responsiveness and choice and helping to meet some environmental
57
Corporatisation can also refer to non-corporate entities like universities or hospitals becoming
corporations, or taking up management structures or other features and behaviours employed by
corporations.
58
National Competition Council, 2002, Competitive neutrality: scope for enhancement, staff
discussion paper. Available at: ncp.ncc.gov.au/docs/PIReCn-001.pdf
59
The APC is the Australian Government's independent research and advisory body
www.pc.gov.uk
OFT1242 | 36
goals.60 There is the Australian Competitive Neutrality Complaints
Office61 which has responsibility for investigating Competitive Neutrality
complaints. Since 1999, 13 formal complaints have been investigated,
four of these were since 2002.62
Spain63
6.28
A new Royal Decree64 introduces specific provisions which aim to
reinforce competitive neutrality in the markets where public enterprises
are active. Thus, the Ministry of Economy and Finance has been
entrusted with the following functions as regards public trading
companies and public law entities:
•
to determine the additional costs derived from their assigned public
service obligations
•
to estimate the advantages obtained in terms of finance as well as
the impact of specific regulations applicable to them
•
to estimate the income that the State Budget should receive as a
compensation for the amounts invested in these entities, considering
60
Productivity Commission 2005, Review of National Competition Policy Reforms, Report no.
33, Canberra. Available at: www.pc.gov.au/__data/assets/pdf_file/0016/46033/ncp.pdf
61
www.pc.gov.au/agcnco/
62
A list of the complaints can be found at
www.pc.gov.au/publications/publications/publications?mode=results&queries_by_type_query=P
ublication&queries_by_report_type_query=Competitive%20Neutrality%20Complaints%20Office
%20Report
63
Information in this section taken from Spain's OECD submission to Working Party 3 on Cooperation and enforcement for conference 19 – 23 October 2009.
64
Royal Decree 1373/2009, implementing Act 33/2003 on the Public Administrations' Wealth.
Decree 1373/2009 came into force on 28 October 28 2009
OFT1242 | 37
the public service obligations and the financial and regulatory
advantages previously calculated.
6.29
65
This is different from the UK, since UK competitive neutrality
arrangements, with a focus on competitive tendering, have generally
been introduced by individual departments, for example the Department
of Health's Cooperation and Competition Panel.65 An overarching
competitive neutrality framework might encourage consistency in the
approach taken by Government departments and would raise awareness
of the importance of the issue of competitive neutrality. However, we
are not aware of current evaluation evidence to suggest whether such a
framework is an effective method of achieving competitive neutrality.
www.ccpanel.org.uk
OFT1242 | 38
7
CREATING MIXED MARKETS
7.1
Competitive neutrality is an important concept that can deliver benefits
to consumers but the process of achieving increased competitive
neutrality might be slow and might involve transitional stages which are
not fully competitively neutral. This can include during the early stages
of reforming markets to deliberately introduce competition against a
former public monopolist.
7.2
In some circumstances methods that are not competitively neutral can
indeed be used to deliberately to encourage entry of private operators
into a market which had previously been dominated by a pubic operator
and may help improve market outcomes despite not being competitively
neutral. One example where this method was used is the introduction of
competition between independent and NHS providers to supply nonemergency hospital care to NHS patients in England: see Box 4 for more
details.
Box 4: Competition between NHS and independent providers of non-emergency
hospital care in England66
Since 2002 competition between the NHS and independent providers67 to supply
non-emergency hospital care to publicly funded patients in England has been
actively promoted by the Government.
The focus has been on competition improving quality of patient outcomes and
value for money. The policy is based on the view that independent sector (IS)
competitors to NHS providers can provide additional capacity and also introduce
new ideas and innovation, which could spur NHS hospitals to improve their
66
This case study draws on a paper published by the Office of Health Economics which
examined competition between independent and NHS providers. Susses, J, 2009, How Fair?
Competition between independent and NHS providers to supply non-emergency hospital care to
NHS patients in England. Available at: www.ohe.org
67
Independent providers include not-for-profit and for-profit providers.
OFT1242 | 39
efficiency and quality. The introduction of IS providers came at the same time as
policies to increase patient choice and new funding mechanisms for hospitals.
Health markets suffer from a number of market failures including information
problems and externalities. In addition there are a number of institutional factors
that create barriers to competition between hospitals. Because of these market
features a balance between competition and regulation needs to be found,
which will lead to the best outcome for society.
Before 2002 there were very few independent providers of NHS funded hospital
care. For competition to have the desired outcome, substantial new entry by IS
providers was required. This was difficult given the incumbency advantages of
NHS hospitals. A hospital is an extremely specialised asset and as such the only
real alternative use for it is other types of hospital care: this means that market
exit costs are high because it is likely to be hard to dispose of the assets upon
exit. To overcome the barriers posed by the existence of an incumbent and high
exit costs it was decided to purchase services through procurement rather than
spot purchases. The granting of a five-year contract would provide a guaranteed
revenue to IS providers and encourage them to enter the market. In 2002 the
Department of Health (DH) announced its intention to run two rounds of
procurement of 'independent sector treatment centres' (ISTCs).
During the first round of procurement DH estimated that ISTC prices would be
about 11.2 per cent higher than the equivalent NHS cost, this premium was
reduced somewhat in round two to an average 7.3 per cent.68 The plan is that
after the initial five-year contract ISTCs are expected to be subject to the same
nationally fixed tariff as NHS providers. Once the contracts expire competition
will be on the basis of attracting patient referrals rather than winning centrally
procured contracts. This is only possible because of the introduction of the
policy of patient choice. At the moment when the contracts expire nondiscretionary cost differences will remain between IS and NHS hospitals, that is,
68
p8-9, Susses, J, 2009, How Fair? Competition between independent and NHS providers to
supply non-emergency hospital care to NHS patients in England. Available at: www.ohe.org
OFT1242 | 40
the market will still not be competitively neutral.69 Once the contracts expire,
ISTCs will operate under the same rules as other independent providers. There
are no plans for any further central procurement of ISTCs.70
There has only been a limited evaluation of the impact of ISTCs and according
to a report by the Kings Fund 'problems with routine data collection, commercial
sensitivity, different regulatory frameworks applying to NHS and independent
sector providers, and a lack of systematic evaluation of the effects of ISTCs on
the NHS … make it difficult to compare different types of provider'71
This case study shows efforts by Government to mitigate the impact of
incumbency advantage enjoyed by the in-house bidders during the competitive
tendering process. In this example, a Government department consciously
decided to offer non-public operators more advantageous terms than public
operators with the aim of increasing capacity in the market and creating new
entry into a market to improve performance by the public operator.
7.3
Different types of operators may face different barriers to entering mixed
markets. Third sector organisations and SMEs face very similar barriers
when competing for public contracts. These barriers primarily arise due
to being small organisations, which means they sometimes do not have
sufficient scale or bidding expertise to compete effectively for large
central Government contracts. The Glover review72 made 12
69
Mason et al, 2009, Should prospective payments be differentiated for public and private
healthcare providers? Health Economics, Policy and Law, vol. 4, p 383 – 403, Cambridge
University Press
70
Naylor, C and Gregory, S, 2009, Briefing: Independent sector treatment centres, The Kings
Fund. Available at:
www.kingsfund.org.uk/research/publications/briefings/independent_sector.html
71
p 8, Naylor, C and Gregory, S, 2009, Briefing: Independent sector treatment centres, The
Kings Fund. Available at:
www.kingsfund.org.uk/research/publications/briefings/independent_sector.html
72
HM Treasury, 2008, Accelerating the SME economic engine: through transparent, simple and
strategic procurement. Available at: www.hm-treasury.gov.uk/glover_review_index.htm
OFT1242 | 41
recommendations to improve SME participation in public procurement.
The recommendations were designed to build on Government initiatives
by:
•
making opportunities as open and transparent as possible
•
making the procurement process equitable and as simple as possible
and
•
managing procurement strategically to encourage:
-
innovation
-
procurer capability and
-
a fair deal for SMEs that participate in the supply chain.
7.4
In some markets that are being opened up to competition it may be that
the incumbency advantages are so large that simply allowing potential
new entrants and incumbents to compete on the same parameters (that
is, have competitive neutrality) would imply that incumbents will always
win the contracts and no new entry will take place. When this is the
case it may be better to encourage entry by private and third sector
operators into formerly public markets by granting them some
competitive advantage (as happened in the example in Box 4). If this
does occur then it is important that competitive neutrality is introduced
once entry has taken place and competition in the market is adequately
regulated.
7.5
It may be possible to overcome incumbency advantages which would
otherwise deter entry while maintaining competitive neutrality, as
occurred, for example in relation to the local loop unbundling (LLU)
which requires BT (the incumbent) to allow competitors access to the
cables which are needed to deliver broadband internet services to
individual homes.73
73
www.ofcom.org.uk/static/archive/oftel/publications/broadband/dsl_facts/LLUbackground.htm
OFT1242 | 42
7.6
It is important to distinguish between granting private firms a
competitive advantage in order to influence market structure and/or
encourage new entry into a market from having public enterprises
operating in markets. Publicly owned enterprises can provide a constraint
to private operators. For example having a municipally owned bus
operator provides the local transport authority with a price comparator
for bids to run locally supported services. This comparison means that
private operators are less likely to artificially adjust their bids to try and
boost profits. This is not the same as allowing public firms competitive
advantage: in the example given the publicly owned bus operator faces
exactly the same market conditions as private bus operators, that is the
market is competitively neutral.
7.7
Having a public operator in the market provides a constraint on private
and third sector operators because it increases the level of competition
in the market. In some circumstances public operators may be more
efficient than those from the private or third sector: in those cases the
public operator should be awarded the contract.
OFT1242 | 43
8
AREAS FOR FURTHER WORK
8.1
This paper has highlighted the importance of competitive neutrality and
the benefits it can bring by helping mixed markets work well.
8.2
Competitive neutrality can be fostered in several ways. These include:
•
reviewing differences in the regulatory, pension and tax treatment of
differences between different types of firms
•
improving guidance on procurement
•
ensuring full cost comparison during public procurement processes
•
having strong corporate governance for state owned enterprises, and
•
introducing an overarching competitive neutrality framework.
8.3
The Julius Review provided an overview of the PSI market and made a
recommendation about the introduction of competitive neutrality into
procurement processes. This might include, for example, ensuring that
full costs of different bidders are compared on a like-for-like basis,
correcting for differences in taxes, pensions or regulation.
8.4
We found that there appears to be some inconsistency in the way
different Government departments take account of competitive neutrality
during procurement. Some departments have advanced competitive
neutrality frameworks while others have more limited provisions. As far
as we are aware, there has been little work so far to evaluate whether
the more complex competitive neutrality approaches have helped deliver
better outcomes. However, inconsistency in itself may cause confusion
for operators, in particular those from the private or third sector, who
might want to enter a new mixed market.
8.5
The differences in tax, pensions and regulation could also be tackled
directly. In practice we recognise that there will be wider effects of any
change in policy, and these need to be considered. This is something
OFT1242 | 44
that would need to be considered on a Government wide basis – it is
typically not something that individual departments are able to address.
8.6
In terms of governance of state-owned bodies, we observed that there
are a number of bodies designed to ensure appropriate corporate
governance of businesses that the UK Government has an interest in.
8.7
There is no UK equivalent of Australia's Competitive Principles
Agreement. Introducing an overarching competitive neutrality framework
might encourage consistency in the approach taken by Government
departments and would raise awareness of the importance of the issue
of competitive neutrality in helping make mixed markets work well. That
said, it does not appear that an overarching framework is a necessary
condition for ensuring competitively neutral outcomes.
8.8
As this paper has demonstrated there is a lot of overlap between issues
of incumbency advantage and competitive neutrality. These incumbency
advantages are hard to solve but we have given examples of a number
of possible approaches. It is very important that incumbency advantages
are minimised to achieve the best outcome in those markets Government
has decided should be turned into mixed markets.
OFT1242 | 45