Mutualization gives power to the employee

The Minister of Finance recently announced that the Government will be introducing legislation which will enable the privatization of non-core programmes and services through a soon-to-be established Efficiency and Reform Authority.  

The Minister anticipates the new Authority will explore the use of “public service mutuals” as a vehicle for structuring independent companies responsible for delivering certain programmess and services.  

The announcement presents an opportunity for Government employees to participate in the development and control of new employee-owned companies that will provide programmes and services previously provided by the Government.  

Minisiter Richards made it clear that the Government’s objective is to reduce expenditure.  However, mutuals and other forms of privatization, have also proven effective in providing higher quality services, attracting investment, stimulating small business creation and optimizing the use of assets.   

In a nutshell, well-designed mutuals harness the entrepreneurial drivers that are often stymied by bureaucracy.   

The current spotlight on mutuals appears to be a result of the UK Government setting the ambitious target of one million civil servants being employed by mutuals by 2015.  

Fortunately, Bermuda can benefit from the experience gained in the UK, and elsewhere, in formulating the legislative framework and developing the business structures. 

First, let’s address what is a public service mutual and how does it differ from other forms of privatization?  

A mutual is a new company (NewCo) that is formed through the spin-off of a government programme or service along with the employees, and possibly the associated intellectual property and assets.  

The NewCo is owned by the employees and may include an ownership stake by the government, customers and independent investors. As the Minister of Finance rightly observed, many mutuals have low capital requirements as the primary resource being transferred is the staff involved in delivering the programme.  

Employee involvement in the ownership and control of the company is a distinguishing feature of a mutual when compared with other forms of privatization.    

Mutuals are able to use business models that have either not been considered or may not be practical to implement within the constraints of a Government Department.  

The flexibility of the mutual to deliver a programme in an optimal manner is essential to capturing efficiencies.  As with any successful business endeavor it is crucial that there is a sound business case to support the enterprise.  

Growth

Ultimately, the NewCo may continue to grow by expanding its services and competing in the broader market.   

The SAGE Commission recommended privatization or outsourcing as a means of reducing Government expenditure and improving service quality.  The Commission cautioned that there are limits to which priviatization and outsourcing may be used given the size of Bermuda.  

Additionally, successful use of this approach, whether it is a mutual, a not for profit entity or a private company, can be complex and requires thorough evaluation and understanding of the business case for taking this action — both by the Government and the potential new company.  

What are the factors that need to be considered in determining whether a mutual is the best fit for independently spinning off a programme or service?  

The Government must be clear in understanding and communicating its objectives for a NewCo and what if any support will be provided by the Government to a NewCo.  For instance, will the Government stipulate the service level standards and compensation for services through a service contract or regulation?  

If the Government intends to provide a contract for services, will the contract be put out to tender at some future time requiring NewCo to compete with other entities to retain the service?  

It is critical that the risks and rewards associated with the enterprise are thoroughly understood by all parties in order to appropriately assign the risks and rewards to the appropriate parties, including customers and the public.  

A lesson learned from the recent experience of UK local authorities is that the successful launch of mutuals appears to benefit from taking an intermediate step of placing the programme or service in an ‘incubator’ before launching it as a NewCo.  

Incubator

Government programmes often rely on other Government programmes and services and these relationships will need to be formalized, eliminated or replaced in the process of becoming an independent company.  

At the incubator stage the Government can address the myriad of considerations, including interdependencies, that will need to be formally addressed.  The incubator stage also allows the new entity to establish an operating track record which helps to attract debt and equity financing in the NewCo.  

While recent experience with mutuals shows that the best results have been in instances where the programme or service has limited capital requirements, capital intensive programmes have also been successfully spun off.  Although capital intensive endeavours may require more up-front planning, the opportunity to create long term business success and growth suggests that these opportunities should not be ignored.  

Structures

What are some of the most common mutual structures?  

• Joint ventures involving the shared ownership of the mutual by the government and employee owned company, in which the government actively shares in both the up-and downside risks and rewards.

• Employee-owned companies where the employees own the company and reinvest or distribute profits earned.

• Cooperative companies where employees and customers share the ownership and control of the company.  

• Private sector companies where shareholders may include investors as well as employees and managers; or employees may opt to sell their ownership interest to equity investors.

• Not-for-profit companies where the primary goal is something other than profit, for example accomplishing a social objective, which may reinvest profits or distribute profits for a social purpose and may also benefit from independent fundraising to support its goals.  

The list of structures above is by no means exhaustive and will depend on the type of services to be delivered, the assignment of risk to the parties and the commercial sustainability of the NewCo.  

The most exciting aspect of mutuals may be the demonstration that there are many ways to accomplish the reduction of Government expenditures and in the process it may be possible to empower employees and improve the quality of services.   

Lori Rockhead is senior manager, Management Consulting and Transactions & Restructuring, Advisory, at KPMG. She may be contacted via phone at 294 2656 or via e-mail at [email protected]