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Time for city to bite the bullet and save millions on its Capita contract

Barcelona paid Liverpool's early termination fee for Suarez - should the council do the same for Capita?

Uruguay's Luis Suarez.(Image: Mike Egerton/PA Wire.)

Followers of the ‘Jaws of Doom’ city defect debate will be aware that Barcelona have just bagged the striker Luis Suarez from Liverpool for a hefty £75 million or so.

What’s interesting here is that Suarez’s contract with Liverpool had a ‘compensatory early termination fee’ – or buy-out clause – said to run into the tens of millions. That’s where the Suarez bite really dug deep.

But Barcelona apparently paid the Suarez buy-out fee up front, because it made sense to do so. The fee got rolled into the costs of the new contract. It made sense financially and on the field, apparently.

We’ve all got experience of being locked into contracts because of early termination fees and costs. If we find a contract is costing us more than we expected, we have to put up with it month on month if the immediate upfront costs of termination can’t be found.

But by not finding them, the overall costs often stack up to be bigger in the long-run. Inertia takes over, and the contract survives to its end even though it makes no real sense financially.

And so it seems with Capita Service Birmingham and Birmingham City Council. The council probably would like to scrap Capita, and it probably makes financial sense to do so.

Indeed the council’s argument for sticking with Capita has shifted from the innovative value added of the contract through to its cost savings through to the fact that the dreaded cancellation fees are simply too much to get out of the deal. “We can’t do it anyway”, seems to be the official line on cancellation.

But while football may be in a world of its own, what’s clear is that in the real world of business, firms often offer to buy out an existing contract so as to get the new business, if they believe that they can run a service more efficiently and still make money even after paying up front the costs of the buy-out.

Indeed many readers will have had a letter from an internet or telecom firm offering to pay the exit fee up to X amount to leave your current provider if you switch to them (often on a better deal). It happens all the time.

All of which leaves me scratching my head with regard to the latest twist in the long-running Capita Service Birmingham saga.

As Post readers will be aware, the city council press office has been in full swing this summer proclaiming the council’s success in getting the cost of the hugely expensive Service Birmingham deal down by £20 million a year as from next year.

By the way, the ‘next year’ here only starts next April, leaving the question as to why the city council hasn’t at the very least negotiated a cut from January 2015 as that’s when the Capita Service Birmingham financial year starts. Why wait another four months? That means millions more in the bank for Capita before the new deal starts.

Of course the council should and could have cut this “Rolls-Royce” contract down to size two years ago on coming into office, thereby saving tens of millions. It didn’t, and we’re all paying for it still.

Sadly, despite a heavily redacted contract being put on line after sustained public pressure, the full details of the Capita deal are still shrouded in secrecy. So for example we don’t know what the cancellation fees are because the council refuses to tell us in the name of “commercial confidentiality”.

But equally the council has never disputed my ‘guestimate’ of cancellation fees of the order of £20 million to £30 milion. And given that the call centre has – rightly – been brought back in-house, such cancellation fees are more likely to be nearer £20 million now than £30 million.

So where does that leave us?

Well, let’s estimate that the costs of running the revised Capita Service Birmingham contract will cost the city council around £600 million between now and the end of the contract.

Might it not be possible that a consortium of local firms could stump up the payment of the cancellation fees of between £20 million and £25 million up front so as to enable the council to buy itself out of the Capita deal, and still come in at an overall cost for the council of somewhere in the region of £400 million to £500 million?

That could save the council between £100 millon and £200 million over the life of the contract, thereby narrowing considerably the “Jaws of Doom” that Sir Albert Bore has stressed so much over the last two years.

But there was never any serious consideration given by the council to getting a consortium of local firms to provide the service. In fact, it seems that the council could ‘do the sums’ on bringing the Service Birmingham contract in house but couldn’t or wouldn’t do the sums on real market testing.

It was a much simpler decision to compare ‘keep Capita’ with ‘bring in-house’, where the latter was seen as the only other game in town. That missed the third and most attractive option of going out to the market – and the one that would probably save most and bring most benefit for the local economy.

We also know from what is legible in the heavily redacted on-line Service Birmingham contract that there is a cancellation clause that means that Capita would have to cooperate with any new provider.

The key point is the council has not properly market-tested the revised Capita Service Birmingham deal. Of course, the council might be right – it may not be possible for other firms to provide this service at lower cost or and/with more benefit locally.

If so, prove it. Market test the contract properly.

* Professor David Bailey works at the Aston Business School

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