By now, the list of privatization opportunities has been narrowed down considerably. The next step is to conduct a complete financial analysis of the selected privatizations.
In order to conduct a "make or buy" analysis for service delivery, the full government and private-service delivery costs must be estimated. Because the process of conducting detailed and accurate cost comparisons is time-consuming and complicated, it should only be attempted after the governor, an executive task force, or legislative commission has analyzed the range of privatization opportunities and made specific privatization recommendations.
It is beyond the scope of this paper to detail the complete process for conducting cost comparisons between in-house and contracted services. However, it is important that the direct and indirect costs of government and contract delivery be computed. This step is made more difficult by the fact that most state governments do not have a system for easily assessing all of the costs of government service delivery. Result: substantial direct costs of government service delivery are frequently omitted when measuring the cost of government provision. (see Figure 6)
Government Provision Costs Often Overlooked
These and other omissions often lead to significant under-reporting of the actual cost of government service provision. A study of 68 jurisdictions found that such inaccurate or inappropriate accounting techniques resulted in the costs of government service delivery being frequently underestimated by up to 30 percent.
The current accounting structure used in most state governments, termed "fund accounting," not only fails to assess many of the costs associated with government service delivery, but the costs that are recorded are often located in two or more cost centers, thus making it even more difficult to identify the actual cost of delivering the service.
Frequently omitted when comparing government and contract service delivery are new or increased revenue streams that result from contracting out a service or selling an asset. These include state and local income taxes, sales taxes, property taxes, and user and license fees. These revenues should all be subtracted from the total cost of contract delivery. This also includes the proceeds from the sale of equipment, facilities, or other assets that are no longer needed by the government due to contracting out the service. Moreover, in order to maintain integrity and credibility, the entire process should be transparent, open and public.
If possible, it is best to have a private accounting firm calculate the full government costs. An outside assessment ensures greater objectivity in the process.
The easiest part of this phase is determining the cost of contract delivery. A Request for Proposal (RFP) or an Invitation to Bid (ITB) is sent out. Alternately, state officials can informally query contractors to determine the approximate cost of private delivery. The bids subsequently received plus the cost of contract administration and monitoring constitute the estimated cost of contract delivery.
It is also important that the costs of administering and monitoring contracts, and relocating, training, or retiring public employees are added to the cost of contracting out. Such costs usually range from 7 percent to 20 percent of total contract costs. (see Figure 7)
Contracting Costs Cost Factors
Source: Colorado State Auditor’s office, Privatization Assessment Workbook, 1989.