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Article Summary

Pack, Janet Rothenberg. 1989. "Privatization and Cost Reduction." Policy Sciences 22: 1-25.

Pack evaluates the success and sustainability of service cost reduction from the perspective of the economic model of cost minimization through competitive bidding. In brief, the model asserts that costs will be minimized when bidding is competitive. Wrapped into the concept of competitive bidding are two additional assumptions required for competitive bids: 1) that government can clearly define and describe output requirements and has enough understanding of the goods cost and value that the level of output chosen maximizes the value to cost ratio, and 2) that firms know production costs.

Using information published in a 1984 publication of the International City Management Association and gathered in 1987 follow-up interviews, Pack examines the experiences of fifteen municipalities which contracted for service provision. She emphasizes that from this small and not-randomly-selected sample we cannot infer anything about the overall frequency of success or failure of contract privatization or the applicability of the model. Instead, she uses the information as qualitative case study data to examine the common factors of success and failure of contract privatization.

Pack identifies evaluative standards for contract privatization: 1) was the bidding competitive, and did the government agency actively encourage competitive bidding?; 2) was the initial cost reduction sustained and what are the common factors of the cases in which it was?; and 3) was the contract disrupted due to unexpected costs; and 4) was the mechanism for contract monitoring a formalized structure or constant interaction between the government agency and the provider?

In the case studies, cost reduction was generally greater when the contracts were competitively bid, and cost reduction was sustained when contracts, when expired, were re-bid rather than renegotiated. Further, agencies that actively encouraged competitive bidding received more bids, and more substantially reduced service costs than those which did not encourage competitive bidding. The article gives three methods utilized by governments to encourage bidding: advertising and widely distributed requests for proposal (RFPs), dividing the contract into smaller pieces to enable small providers to compete, and incentive provisions (contract clauses dividing the financial risk between government and the service provider).

The type of service provided also appeared important to cost reduction and sustainability. Among these cases, competitively bid labor intensive services were likely to achieve great initial savings and to sustain reduced costs. More capital intensive production processes were less able to sustain cost savings.

Contract disruption generally occurs when a firm does not know production costs at the time of the bid and costs exceed those estimated. When costs are much higher than those estimated, the firm can absorb the cost, renegotiate the contract, or renege entirely. When the private firm reneges on a contract, the government agency remains responsible for providing the service by either returning to direct government provision or by re-letting the contract. Contract disruption can incur large, unanticipated financial and political costs, and is a risk of private contracting not often calculated into the privatization decision. In the cases where contract disruption occurred, Pack finds that the majority of them used relatively expensive formal monitoring systems which discerned the problem after it was serious. Agreements of constant interaction between government and service provider appeared to be a more successful monitoring tool.