28 – Local government shared services. Is it the silver bullet for rate capping? – Part 1

Posted by Colin Weatherby                                                                                         620 words

The Victorian state government plan to cap municipal rates has revived discussion about shared services. Some leaders see shared services as a silver bullet to reduce costs. What potential do shared services have to help councils respond to rate capping?

The article Government shared service back in vogue notes that shared services are usually justified by business cases promising operational efficiencies and cost savings. However, the article cites numerous examples of shared services that have failed to deliver.

In 2011, the West Australian government disbanded its Office of Shared Services centre after an Economic Regulation Authority review found the project was over budget and unlikely to deliver promised savings of $57 million a year. Instead the project had cost $401 million and achieved minimal savings.

The Queensland Health payroll upgrade was developed under the auspices of a shared services group. Originally with a budget of $98 million, and due for completion in July 2008, the project was the subject of a royal commission last year and is expected to cost taxpayers $1.2 billion by 2020.

In The Whitehall Effect John Seddon documents examples of similar failures in the United Kingdom. The track record of failure suggests that there are significant risks associated with shared services. So why are they regularly on the public sector reform agenda?

In his 2010 paper, Why do we believe in economies of scale?, Seddon summarises the arguments for economies of scale in terms of:

  • Specialisation and standardisation that will lead to lower costs and greater productivity.
  • Cost savings will be made through common IT systems, less buildings and fewer managers.

On the face of things, sharing services makes sense. It can create economies through increasing scale, which can reduce costs. Scale economies occur when capital and fixed costs do not increase proportionally with growth in capacity. A service or facility capable of producing twice as much does not cost twice as much to establish. The cost per unit of output decreases with increasing scale as the fixed costs are spread over more units of output.

Scale economies also occur when facilities are ‘indivisible’ and a minimum amount of capacity exists that must be utilised.

Economies of scale

At some point on a growth curve diseconomies of scale occur when the cost per unit of output starts to increase with each additional unit of output. This can happen when the costs of complexity involved in running a large operation can increase faster than capacity because of the level of effort required to coordinate work and communicate. The theory about how economies and savings can be achieved through shared services is fine. In practice, it can be quite different.

In The Whitehall Effect Seddon describes ‘less-of-a-shared-resource’ savings where the fixed costs for management, facilities or information technology are spread across more units of output. He describes these savings as ‘real and unequivocal’. There can be costs involved in making these savings if redundancy payments are required, facilities are sold at a loss or leases are broken, and if information technology contracts cannot be terminated. But savings can be made in the longer term.

Seddon directs most of his criticism of shared services towards the promise of lower transaction costs through scale economies. He believes that these are only achievable by eliminating costs that can and should be eliminated without the expense and risk involved in entering into shared services. In particular, he is critical of the need for ‘back office’ operations. More in the Part 2.

Pennington, Sylvia 2014. Government shared service back in vogue in The Age, April 21.

Seddon, John 2014. The Whitehall Effect.

Seddon, John 2010. Why do we believe in economies of scale? http://s3.amazonaws.com/connected_republic/attachments/33/Why_do_we_believe_in_economy_of_scale.pdf.