Rhodri Davies, Programme Leader, Giving Thought

Rhodri Davies

Head of Policy

Charities Aid Foundation

The role of giving

An analysis of Funding Good Outcomes

4 October 2012

This is exciting: rather than writing about interesting reports or research by other people (which is my usual MO on this blog) I find myself able to write a blog post about a report of my own! We've just launched a paper entitled Funding Good Outcomes: Using social investment to support payment by results, which I wrote (based very largely, I should point out, on conversations with our excellent social investment team, CAF Venturesome, about their experience in the social investment market).

The report argues that payment-by-results (PbR) is a good idea in theory but poor implementation looks likely to lead to it failing in practice, as charities and social enterprises will not be able to play the sort of role as service providers that the Government clearly wants them to play.

NCVO released a survey showing that 7 out of 10 charities that are sub-contracting in the Work Programme thought their contracts were at risk of failure. This demonstrates the level of concern not-for-profits* have about the way PbR is being implemented. Of course, as well as the broader issues with PbR that are exemplified by the Work Programme, there are specific problems stemming from the prime contractor/subcontractor model which are not inherent to all PbR approaches. However, since it looks likely that the Work Programme will provide a template for many future PbR initiatives there is definitely cause for alarm.

Overcoming the working capital gap

In terms of the broader issues, the fact that most PbR contract payments are entirely end-loaded (i.e. made only once agreed targets have been met) is a real concern, as it means that organisations bidding for them require significant working capital. This is unlikely to be a problem for commercial organisations that can cover these costs from their reserves or obtain mainstream finance easily, but for not-for-profits, which struggle to obtain commercial finance and are often asset-poor (and are in fact forbidden from keeping large reserves), it can present a real challenge.

Social investment can, and already does, play a crucial role in overcoming the working capital gap for not-for-profits. Socially-motivated investors may offer loans or other types of finance at below-market rates because they are willing to balance the potential financial returns against social ones. The problem, and the central point of this report, is that the way PbR is currently being implemented is not only presenting a barrier to the not-for-profits that might want to deliver services, but also to the social investors that might want to support them in doing so.

The key problems can be snappily (and as ever with these things, slightly artificially) categorised as pertaining to three Rs: Risk, Return and Rewards.

Risks around Payment by results

Risk is really the central issue around PbR. Whilst there is certainly an argument that PbR can deliver better services because of the room it leaves for innovation, from a commissioner’s point of view the more basic appeal of PbR is that it can enable a transfer of risk away from themselves because they only pay if outcomes are successfully delivered. This is why social investment has a part to play: investors with social motivations may well be willing to accept a higher level of financial risk than a commissioner would, because those investors are willing to balance financial returns against the social value produced.

One of the points we wanted to get across in the report is that the mindset of commissioners must be one of risk sharing rather than risk transfer. Of course commissioners want to minimise their own risks, and if social investors are happy to help them do this, so much the better. But only up to a point. We do not believe that it is right to use PbR as a way of effectively outsourcing the entire risk of funding public services.

Structuring PbR for not-for-profits

In practical terms, this would mean structuring PbR contracts with not-for-profits so that a proportion of payments are made up front to cover core costs and a proportion are made only when (or if) agreed outcomes are delivered. This would represent a much fairer balance of risk between the commissioner and a not-for-profit service deliverer than a contract where 100 per cent of payments are at risk.

Another crucial point we want to make (and one that not everyone will necessarily agree with) is that where there is an ambition to bring in additional commercial capital to fund PbR, social investors should not be used to “shield” these commercial investors in order to reduce their level of risk. It is wrong to exploit the motives of social investors in order to bring in investors who prioritise near-commercial returns, particularly given that PbR is still unproven as a means of delivering social outcomes.

Skewing results

When I (slightly artificially) use the word “returns”, I intend it to refer to the financial rewards available through PbR (as opposed to the social value created). One of the key recommendations we make in the report is that the not-for-profits delivering the services are able to share in any financial upside associated with outperforming targets. At the moment this is not the case in many PbR contracts, so not-for-profits are being expected to take on the downside risk with no possibility of sharing in any upside returns.

By results, I mean both the actual social outcomes that define PbR contracts and the broader organisational outcomes for not-for-profits that deliver these contracts. In terms of the former, the main issue is that despite the continued rhetoric about outcomes, the majority of commissioners are still defining contracts in terms of other measures such as inputs or outputs. This is understandable given the challenges of working with outcomes, but the concern is whether these other measures are effective proxies for outcomes. If they are not, then given the tendency of organisations to skew their activities towards what is measured, there is a real danger of distorting the work of not-for-profits.

Developing new skills

In terms of organisational outcomes our key point is that PbR contracts, and any social investment in them, should be structured so that the not-for-profits delivering the services are able to develop new skills and capacities which will make them stronger as organisations and better able to compete for future contracts. This will obviously require input in terms of money and skills from social investment intermediaries and commissioners, and this additional cost should be factored into the cost of contracts.

No-one expects commissioners to do this out of altruism, of course, but there is a clearly a strong argument that the development of a wider pool of not-for-profit organisations able to deliver high-quality services is in the long-term interest of the commissioner. Additionally, the development of a greater number of investment-ready not-for-profits it is very much in line with the Government’s wider aim of growing the market for social investment in the UK. Of course this assumes that “joined-up government” is something that actually happens in practice, which is not often the case, but perhaps it pays to be optimistic…

Social investment intermediaries

From the point of view of social investment intermediaries, aiming to develop the skills and capacity of investees would appear to be a no-brainer. However, there is a danger that good intentions can lead to unintended negative consequences in this area. Intermediaries that try to “protect” not-for-profits from some of the responsibilities and challenges involved in public service delivery in order to “free them up to do what they do best” are almost certainly doing so with the best of intentions, but as a result they may prevent the not-for-profit from developing skills that would stand them in good stead in the future. For instance, while a small not-for-profit might welcome not having to deal with contract management, it might actually be better for them in the long term if they developed their skills in this area so that they were better placed to compete for and deliver future contracts.

It is vital, therefore, that when social investors and intermediaries make PbR-linked investments they look for ways to help up-skill the not-for-profits they work with at the same time.

Addressing PbR issues

The long and short of the report is that PbR could be a positive thing for charities and social enterprises and the social investors who want to back them, but there are some significant issues that need addressing if this is to be the case. Hopefully our report will draw attention to these issues, and we have made a number of recommendations for how these challenges can be overcome so that PbR is an opportunity for not-for-profits rather than a threat.

* Just a quick note at this point on terminology: I have never quite decided what pithy term to use that basically means “charities and social enterprises and all the other sorts of organisations that are essentially a bit like that”. Given how often I need to refer to them in the report, and in this blog post, I decided to plump for” not-for-profit organisation” or “not-for-profit”. I realise that this might seem like a jarring Americanism to some, and that there are live debates about the suitability of the term for some social enterprises, but I am hoping that by acknowledging these issues I can then gracefully ignore them…