The
Ratio of Beef Cubes to Onion (6:1) in Hungarian Goulash and Public Sector
Contracting: Market-Like or Market-Lite?
School of Public Policy and Management
The Ohio State University
2100 Neil Avenue
Columbus, Ohio 43210
(614) 292-7423
marvel.1@osu.edu
Department of Economics and College of Law
The Ohio State University
1945 North High Street
Columbus, Ohio 43210
June 2003
Imagine that as you are perusing two groups of food service contracts, you happen upon the following mandates in the first group:
· Prescribed dimensions of crumb cake,
· Number of trash bags required per meal,
· Minimum size of placemats,
· Recipe and required ingredients for Hungarian goulash (including the aforementioned beef cube to onion ratio).
And the following in the second group:
· Keep services adequately serviced and supplied with appropriate merchandise of good quality at reasonable prices.
Would you know which one contains public sector contracts and which one contains private sector contracts?
With many public sector organizations heeding the often-heard, often-stern admonition to join the load shed/privatize/be-more-like-business/contract-out club, it is useful to explore the closeness of the analog between private sector practices and their adoption by public sector entities. Specifically, we want to compare and contrast public and private sector contracting. Does the nature of the contract written vary systematically from one sector to the other? (The answer is an emphatic yes.) Can public sector organizations achieve efficiency gains comparable to those posted by a private firm in its contracting? (This answer also is a resounding no. Public sector contracts may reduce the cost of service provision but, unlike private sector arrangements, they ignore demand-side configurations.)
We have begun collecting contracts from vendors of products that service both the government and private sector. In order to control for the “government services inherently are more complex” argument, we review contracts where the service contracted for is the same, comparing apples to apples. We have obtained contracts from a food service vendor that deals extensively with both public and private customers. The company offers both cafeteria-style food delivery and vending machines. A review of the contracts indicates that a cafeteria contract for a Veterans Administration hospital or a U.S. Post Office facility will be dramatically longer and more detailed than a far larger dollar volume contract for cafeteria service for an automobile plant. The comparison is particularly instructive, since the size of the automakers in question indicates that the degree of detail present in the government contracts is not simply due to the problems of monitoring purchasing agents in large organizations.
Our vendor’s standard contract for these items is six pages long. Of these six pages, somewhat less than a single page is devoted to detailing the vendor’s responsibilities. The section detailing the food to be provided reads in its entirety as follows:
Pursuant to the provisions of this Agreement, will operate and manage its Services hereunder at such locations as shall be agreed upon, keep its Services adequately serviced and supplied with appropriate merchandise of good quality at reasonable prices, and, where vending is involved, will install service and maintain at high standards of quality, sanitation and cleanliness such mutually agreed number and type of vending machines at mutually agreed locations for the sale of food products, nonalcoholic beverages, tobacco products and other mutually agreed articles.
The financial arrangements are not a part of the stock contract, but are added for each customer.
The contrast for public contracts is quite remarkable. We highlight three such contracts, one for a prison cafeteria, the second for a nursing home and the third for an airport. The nursing home contract consists of 50 legal sized pages together with nine appendices, and multiple pages at the front of the document. The food specifications are elaborate indeed. They indicate acceptable portions and times of the year when fresh fruits can be in fact considered fresh. Sample stipulations include:
• “When crumb cake is served, it shall be 3” x 2-1/2” and 1-1/2” high.”
• “Ham and cheese sandwiches shall be made with 2 oz. ham and 1 oz. cheese per sandwich.”
• “When fresh fruit is on the menu, each site must receive only one variety of fruit. However, the Company may choose to send one variety of fruit to some sites and other variety of fruit to other sites.”
The contract also specifies the number of trash bags per week, the minimum size of the place mats (plain, of course), and that the delivery drivers, who “shall have a neat and pleasant appearance” must “allow 12 minutes per site for the counting of food.” The puzzled contractor receives helpful hints: “a one (1) ounce meatball or lightly breaded fish stick does not contain one ounce of meat or fish. A stuffed cabbage or pepper which weighs three ounces (including the rice and cabbage or pepper) does not contain three (3) ounces of meat.” Recipes are also sketched, indicating what ingredients must be present in a Hungarian goulash, for instance, but there is some flexibility: “The Company shall use standardized recipes, and any as might be supplied by (the contracting agency).”
The penal institution contract is somewhat less elaborate. Instead of specifying details about each of the ingredients, it simply provides daily menus. These, however are specified in considerable detail, including weights of all portions down to sugar (2 tsp. for breakfast) and margarine (2 oz.) No flexibility is permitted.
The contract for the airport, a political subdivision, stipulates that the airport commission, and not the foodservice company, has the exclusive right to approve, establish and revise prices, menus, portion sizes, food product specifications, hours of operation for individual units and standards for the type and quantity of service. In addition, the contract requires that the contractor provide a detailed policy and procedures manual dealing with its internal operations. No modification or amendment to the manual is permitted without approval of the commission.
Why does the public sector write such contracts? Is “fear of discretion”, as Steven Kelman contends, the culprit? Certainly some contract monitors may take comfort in adhering to established rules, thereby reducing their ex post discretion and vulnerability. But the very act of drafting complex rules is in itself an exercise in discretion—ex ante discretion. By careful specification, the contract drafter uses its discretion to determine the services to be provided as opposed to a true market solution that would offer a far richer range of alternatives.
The public sector has focused on minimizing the cost of service provision (though obviously not transaction costs) in the contracting process. In so doing, it fails to address the “rest of the story”—designing products to increase consumer demand. Markets not only minimize cost but also record and respond to consumer preferences in order to determine what that output should be. The fundamental difference between public and private sector contracts is that the former specify only inputs in detail. In contrast, the private sector contracts we have investigated continue in force only so long as the ultimate consumers of the service are satisfied with the outputs. Miguel de Cervantes’ familiar maxim that “the proof of the pudding is in the eating” is fundamental to predicting marketplace success, but in government contracting, whatever proof is asked for comes only from the ingredients.
The detailed specifications of public sector contracts have the disadvantage of freezing in place the actions to be performed in the future, and the remuneration of those actions, irrespective of intervening events. This approach has the (probable) advantage of reducing the scope for ex post contractual opportunism. But the cost of doing so is that the very advantages of dealing with an outside contractor instead of providing the function internally are undermined. The contractor is converted from an independent provider of the service in question who receives benefits or harm depending on the job s/he does to a manager employed by the state, a member of the bureaucracy in all but title. Under current contracting practice, perhaps one should relabel privatization as publicization.
Why the disconnect between contracting in the public and private sectors? A private sector firm will provide food service to its employees only to the extent the service aids in its efforts to attract and retain good employees en route to its goal of enhanced profitability. Both the contractor and food service provider necessarily have the preferences of the employee consumers as their target. The public sector contractor faces a less well-defined link between consumer satisfaction and its budget. The result is the marginalization of consumer preferences so clearly apparent in our sample of contracts.
The principal mechanism for enforcement of contracts with the sparse specifications typical of private sector contracts is likely to be reputational. The characteristics of public contracting, however, reduce the scope for reputational penalties for firms that fail to perform according to specifications. The detailed specification of contracts together with bidding processes that award the contract in question to the lowest bidder reduce or eliminate the value of reputation in winning such contracts. Firms perceived to provide high quality services are not thereby more likely to be selected for a contract unless the terms of the contract are written in idiosyncratic fashion. Firms that serve both the public and private sectors may tailor their products and services separately for the two. Over time, due to adverse selection, firms attuned to meeting specifications rather than responding to consumer preferences will dominate the pool of successful public sector contractors.
Such firms, like the public contractors, will prefer the “market-lite” approach of producing according to a recipe over a “market-like” requirement that the recipe respond to consumer taste. The resulting equilibrium will fall short of a market solution. Costs may be low, but so will satisfaction.