Shared services – too good to be true?

Three hard truths for governments looking to save money through shared back-office services

Last week, to the delight of many consultants, lobbyists and other government onlookers, the Office of Management and Budget (OMB) in the USA announced a major development in President Obama’s management agenda – the creation of a central governance board to oversee the ‘aggressive’ pursuit of shared services across the federal government

Shared services are a type of organizational reform intended to deliver cheaper and better quality support functions – like payroll, finance, human resources and purchasing. Rather than individual agencies meeting their own needs in-house, they collaborate with one another (and sometimes with the private sector) to provide standardized support to multiple organizations. The main advantages come from greater economies of scale, scope and learning than individual organizations can achieve on their own.

Last week’s announcement is only the latest instance of a government signing up to the shared services trend. Reforms are already underway here in the UK; across Europe in countries as diverse as Belgium, Sweden and Estonia; and much further afield in places like Singapore, Australia and New Zealand. Indeed, since the global financial crisis, shared services have come of age, as budget cuts force politicians and public managers to re-think priorities and methods of organisation.

However, despite this groundswell of support, it is increasingly apparent that shared services are no fail-safe efficiency solution. Amid the success stories are many hard truths about the difficulty of achieving cost savings by restructuring organizations. Three are explained below.

Hard Truth 1: You’ll have to spend to save.

Shared services require considerable upfront investment. From new IT infrastructure and the re-design of internal processes, to consultancy fees, staff re-locations and redundancies – organisations must spend if they are to save.

This much is widely recognized by reformers, and yet, in practice, cost overruns are frequent. A major shared services programme in Western Australia exceeded its start-up budget of $82mAUD several times over, and was eventually cancelled as spending outweighed benefits. Similarly, in the UK, the implementation bill in the transport sector more than tripled original estimates, while the expected savings gradually declined.

More research is needed into why start-up costs escalate. No doubt poor project management is sometimes a factor, but more fundamental are the unforeseen complexities of re-modeling management processes and adopting new IT platforms. Consequently, governments looking to reform should ensure the business case is sufficiently favorable to accommodate large errors in forecasted implementation costs.

Hard Truth 2: You’ll face some tough trade-offs between production costs and transaction costs.

Economies of scale mean that multi-agency support services should lower unit costs. Higher volumes of work distribute fixed overheads, increase staff specialization and allow more investment in technology and expertise. But of equal importance to the labour and resource required to turn inputs into outputs (‘production costs’), are the costs of directing and monitoring those processes – what economist call ‘transaction costs’.

Transaction costs are incurred in calculating what goods or services are required, writing detailed specifications for them, undergoing a tendering process, monitoring the performance of the vendor, up-dating the contract, and so on. Often there is a trade-off between production and transaction costs. Because of scale economies, services might be produced more cheaply outside of the organization, but this entails significantly higher transaction costs.

Research in Estonia did indeed find that shared services increased the number of managers required to coordinate the separate client and provider. And in Northern Ireland, the reform led to fewer staff redundancies than planned in client agencies, and an increase in higher-grade staff.

Business cases should therefore take account of the likely increase in transaction costs with shared services, as well as the potential for lower production costs.

Hard Truth 3: You’ll face unexpected problems with standardization.

Finally, the standardization of processes required for organizations to share services brings unforeseen challenges.

There is a risk that the rules and regulations enforcing standardization become ends in themselves, assuming more importance than primary organizational objectives. This is known as ‘goal displacement’, and is a widely recognized pathology of rule-based bureaucracy.

Furthermore, organizational sociologists also attribute slower decision-making and reduced innovation in organizations to bureaucratic structures. The over-specification of resources and procedures makes it difficult to think outside the box and more cumbersome to effect changes.

Rigidity, delay and a fixation with process over outcomes are all familiar criticisms of public institutions. Governments should thus be mindful not to exacerbate these problems when adopting shared services.

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Overall, the three hard truths – about escalating investment, increased transaction costs, and the problems of standardization – do not suggest that shared services are simply unworkable in government. But they do indicate that this type of reform is neither an easy fix nor a comprehensive solution to government inefficiency, and in some cases might do more harm than good.

Caution and a measure of skepticism are thus the watchwords for governments – in the US and elsewhere – embarking on shared services reforms.

Dr Thomas Elston is a Postdoctoral Research Fellow at the Blavatnik School of Government and a specialist in public administration. His current research, funded by the Leverhulme Trust, is looking into the potential for shared services to overcome the traditional dilemma between centralized and decentralized support functions in government. A BSG Policy Memo on the dos and don’ts of shared services can be downloaded from the BSG website, and a working paper on the risks of adopting shared services can be requested from Dr Elston.