Insourcing: what do you need to know?

Mike Pierides and Caron Gosling look at the issues for local authorities considering bringing services back in-house.

The sourcing cycle, including within local government, continues to spin with many services previously outsourced returning in-house. This recent trend, insourcing, has seen local authorities opting to cancel or not renew contracts with private companies, for functions and processes ranging from IT and property management to back-office functions.

The move towards insourcing has been driven by a variety of factors. While it was hoped that outsourcing would save money, costs associated with unexpected complications have led many to believe that insourcing itself can be a cost-cutter for local government. Nevertheless, the potential advantages of regaining control over critical functions and cost reduction must be weighed up against the challenges presented by insourcing.

Drivers for insourcing

Allowing local government to regain or improve control over critical functions. Functions that may have been perceived as low level or easy to deliver front-office functions have proven to significantly impact organisations.

Increasing flexibility. The duration of outsourcing agreements means change is inevitable. However, this can be a time consuming, rigid process which requires in-depth engagement with the supplier. Insourcing can decrease the cost and speed associated with change, while catering for greater control in determining the nature of the change.

A simplified purchasing route for available technologies. The increasing prevalence of “as a service” and cloud offerings means local government can manage its service in-house and does not have to rely on the legacy technology and infrastructure supplied or serviced by private outsourcers.

Cost reduction. Insourcing evades the supplier margin charged by outsourcers, while the increasing costs of outsourcing centres are decreasing the appeal of labour arbitrage. Moreover, the growth of automation and robotics is further reducing the labour component of certain activities

Insourcing challenges

Insourcing requires consideration of challenges presented by, amongst other things: (i) recruitment and training of personnel, or transfer of personnel; (ii) amendments to processes (iii) data transfers, systems reconfiguration, user access modification; (iv) IT licences being reviewed and assured; (v) updated governance; and (vi) new reporting.

Operationally, the key risk facing local government is the new operating model that will be implemented to replace the previously outsourced function or service. Local government must clearly define the scope of the insourced function, establish its role within the organisation and determine how it will fit with existing services. It is imperative that the new operating model does not create deficiencies in operations. The risk facing local government is that the transition from outsourced to insourced may, itself, detrimentally impact service and costs. Moreover, while contractual provisions may enable local government to extract part of a function, complications are common. If the insourcing occurs during the lifetime of an outsourcing agreement, there may be a lack of clarity as to what can be terminated or transferred within contractual provisions for partial termination.

Where the outsourcing agreement grants complete flexibility to terminate parts of the service, local government still faces the challenges of practical implementation in terms of cost allocation and impact on remaining services, meaning a strong barrier to insourcing remains.

Personnel issues / TUPE

A key consideration for an insourcing involving a labour-intensive function is the extent to which key employees can be transferred back to local government. A transaction-by-transaction evaluation is required but an insourcing is likely to fall within the remit of a TUPE transfer. The business requirements of the insourcing will determine whether it can be structured so as to establish the application of TUPE, though this may be subject to negotiations.

It is vital to consider the impact of the existing outsourcing contract on personnel. Despite the likelihood that TUPE applies and that the assigned employees will transfer back in-house, there is a risk that employees, particularly sought after senior members, could opt-out of the transfer. These employees are often critical to the function and an insourcing creates an opportunity to resign on the transfer date, without the formality of a termination notice. This has the potential to undermine the future provision of the relevant function or process as expertise and know-how are critical.

Moreover, under TUPE, the terms and conditions of employment are protected meaning there is little scope to adjust employees’ contracts to align them to business needs, thereby further hindering the insourcing process.

There are further government specific considerations. The activities may be insourced to a local authority, central government itself or a special purpose vehicle (SPV) set up specifically for the services. It is likely that since the original outsourcing, there has been a change in personnel charged with the provision of the function. Therefore, thought must be given as to how employees will be transferred to the public sector, particularly with regards to cultural adjustment. It is immaterial whether the services will be provided through an SPV as ultimately, where it is wholly owned by local/central government, the transfer of employees is likely to yield the same public/private sector employee relations issues.

The differences between public and private sector employment could result in a contentious insourcing and could involve significant negotiations with recognised unions on matters including:

• The extent to which local/central government’s recognition arrangements with unions will apply to the newly insourced functions. Unions may view this as an opportunity to expand their membership.
• Whether the newly insourced employees will be entitled to partake in the same pension scheme as other employees (for example, the Local Government Pension Scheme) particularly as some of the insourced employees may be deferred members of that scheme.
• The possibility of having a two-tier workforce, where existing employees may be required to work alongside those transferring from the private sector who are on different and potentially more favourable terms and conditions of employment.
• The recruitment and incentivisation of key and experienced employees when competing with private sector employers and ensuring they are retained in the public sector.

Conclusion

The sourcing landscape is always changing and the current trend of insourcing adds another wheel to the outsourcing/procurement cycle. Indeed, despite an increase in insourcing, outsourcing is still on the rise globally. [1] The constant evolvement of service needs and corresponding requirements to either outsource functions or return them in house explains this shifting dynamic as influenced by the drivers set out above. Contractual flexibility will help organisations to keep pace with these changes and organisations must demonstrate a clear operational understanding relating to delivery models and risk.

Mike Pierides is a partner and Caron Gosling is counsel at Pillsbury Winthrop Shaw Pittman.