GAO

GAO/GGD-98-87

April 1998

United States General Accounting Office

General Government Division

Privatization

Questions State

and Local

Decisionmakers

Used When

Considering

Privatization

Options

Page 1 GAO/GGD-98-87

Over the past several years, state and

local governments have increased their

use of various types of privatization.

Privatization is commonly defined as

any process that is aimed at shifting

functions and responsibilities, in whole

or in part, from the government to the

private sector through such activities

as contracting out or asset sales.1 A

1997 Council of State Governments’

survey found that state agencies

responsible for transportation,

corrections, higher education, and

social services had all increased

privatization activities since 1988.2

According to the International City/

County Management Association, city

governments have also increased the

number and types of services

contracted, such as child welfare

programs, health services, street

maintenance, and data processing.3

Congress and the administration

indicated an interest in having the

federal government increase its use of

privatization. In light of this interest,

we were asked by the Chairman of the

1See Terms Related to Privatization

Activities and Processes (GAO/GGD-97-

121, July 1997).

2Private Practices: A Review of

Privatization in State Government, Council

of State Governments (Lexington, KY: Nov.

1997).

3International City/County Management

Association Municipal Year Book 1994:

Alternative Service Delivery in Local

Government, 1982-1992 (Washington, D.C.:

1994), p. 28.

Preface
Page 2 GAO/GGD-98-87

House Task Force on Privatization to

identify lessons learned by state and

city governments in implementing

privatization efforts. Our subsequent

report, Privatization: Lessons Learned

by State and Local Governments (GAO/

GGD-97-48, Mar. 14, 1997), discussed

privatization lessons learned by, and

the related experiences of, the states of

Georgia, Massachusetts, Michigan,

New York, and Virginia as well as the

city of Indianapolis, Indiana.

This publication responds to a request

from the task force Chairman and

several other Members of the House of

Representatives that we identify the

critical questions that state and local

decisionmakers found useful when

considering whether to privatize a

government activity. The questions in

this publication were identified by

decisionmakers in the state and local

governments we discussed in our

March 1997 report and correspond to

the lessons learned by those

governments. In preparing this

publication, in March 1998, we

provided privatization officials from

the six governments a draft of the

questions for their review and

comment. All six governments

concurred with the questions and

provided comments, which we have

included as appropriate.
Page 3 GAO/GGD-98-87

Major contributors to this publication

were John K. Needham, Donald L.

Bumgardner, Kiki Theodoropoulos,

and Marlene Zacharias. If there are

any questions on the material in this

publication, please contact me on

(202) 512-8676.

J. Christopher Mihm

Associate Director, Federal

Management and Workforce Issues
Page 4 GAO/GGD-98-87

Contents

Preface 1

Introduction 6

Political Champion 8

Questions Concerning Political Champion Issues 9

Implementation Structure 10

Questions Concerning Implementation Structure 11

Legislative and Resource Changes 12

Questions Concerning Legislative

 and Resource Changes 13

Reliable Cost Data 14

Questions Concerning Reliable Cost Data 15

Strategies for Workforce Transition 16

Questions Concerning Workforce Transition 17

Monitoring and Oversight 18

Questions Concerning Monitoring and Oversight 19

Notes 20
Page 5 GAO/GGD-98-87
Page 6 GAO/GGD-98-87

The six governments we visited

tailored their approaches to

privatization to their particular

political, economic, and labor

environments. We selected the states

of Georgia, Massachusetts, Michigan,

New York, and Virginia because, at the

time, they had the most extensive

privatization efforts involving activities

that correlate with those performed at

the federal level. We selected the city

of Indianapolis because it was cited

more frequently by the panel of

privatization experts we consulted

than any other city or state for its

privatization experience. On the basis

of our review of the relevant literature,

the views of a panel of privatization

experts, and our work at the state and

local governments, we identified--as

shown in the figure--six lessons that

were generally common to all of the

governments in implementing

privatization initiatives.

Introduction
Page 7 GAO/GGD-98-87

Figure: Lessons Common to State and Local Governments
Page 8 GAO/GGD-98-87

Privatization can be best introduced

and sustained when there is a

committed political leader to champion

it. In the six governments, a political

leader or, in one case, several leaders

working in concert played a crucial

role in introducing privatization.

These leaders built internal and

external support for privatization,

sustained momentum for their

privatization initiatives, and adjusted

implementation strategies when

barriers to privatization arose.

The chief executive (i.e., the governor

or mayor) was the political champion

for the most recent privatization

efforts in Georgia, Massachusetts,

Michigan, New York, and Indianapolis.

In Virginia, key state legislators and the

governor worked together to introduce

new privatization initiatives.

Political Champion
Page 9 GAO/GGD-98-87

Questions Concerning Political

Champion Issues

1. Who in the government will provide leadership in assessing

the case for privatization and supporting the privatization effort

once it is under way?

2. Is the activity viewed by policymakers and other

stakeholders as one the government should (1) provide and

produce, (2) provide but not produce, or (3) not produce, and

have other options to improve the activity been considered?

3. Should the government involve the private sector in the

activity or is the activity so intimately related to the public

interest that it is inherently governmental?

4. Will private sector participation improve performance of the

activity? That is:

• Are there substantial problems in current service delivery?

• Are there benchmarks that indicate potential for cost savings

or service quality improvements?

• Will privatization increase choices available to

citizens?

5. Do policymakers, agency officials, and other stakeholders

agree on the goals the privatization is to achieve?

6. Will the users of the service, interest groups, or public

officials be resistant to changes in service providers? If so,

how will this resistance be mitigated?

7. Is there a need for an advisory group or commission to

identify activities that are candidates for privatization and to

build consensus for it?
Page 10 GAO/GGD-98-87

Once political leaders introduce

privatization, governments need to

establish an organizational and

analytical structure to implement the

privatization effort. This structure can

include commissions, staff offices, and

analytical frameworks for privatization

decisionmaking. Five of the six

governments we reviewed established

governmentwide commissions to

identify privatization opportunities

among government activities and to set

policies to guide privatization

initiatives. The commissions were

created either by the chief executive

(in Georgia, Michigan, New York, and

Indianapolis) or by the state legislature

(in Virginia). Massachusetts did not

use a commission; instead, cabinet

secretaries selected the government

activities to privatize. The

governments found that privatization

can take various forms, such as

contracting out and asset sales, and

that implementation strategies and

analyses need to be tailored to the

project or situation and will likely vary

depending on the form of privatization.

Implementation Structure
Page 11 GAO/GGD-98-87

1. Given the nature of the activity, what type of privatization

would be most viable and best serve the public interest (e.g.,

contracting out, managed competition, divestiture)?

2. Is the activity already performed in the private sector?

3. Is there a competitive marketplace? If not, can one be

created?

4. Are there barriers to entry by private firms, such as

significant start-up costs? If so, can they be mitigated?

5. Are there factors that could limit the use of privatization,

such as “natural monopolies,” in which production cannot be

duplicated (e.g., a single source for city water supply); and

“public goods” that cannot sustain private markets? If so, how

could these factors be mitigated?

6. Will the contractual arrangements and the type of service

permit the government to switch from one service provider to

another without serious disruption in the flow of service or

undue cost at the end of the contract or option year?

7. Will there be an office and/or knowledgeable staff available

to collect and analyze performance and cost data and provide

technical assistance to agencies?

8. Have the legal, financial, and technical risks/liabilities to the

government been identified, considered, and evaluated?

9. What will be done with the activity’s current facilities,

technology, and other resources?

Questions Concerning

Implementation Structure
Page 12 GAO/GGD-98-87

Governments may need to enact

legislative changes and/or reduce

resources available to government

agencies in order to encourage greater

use of privatization. Georgia, for

example, enacted legislation to reform

the state’s civil service and to reduce

the operating funds of state agencies.

Virginia reduced the size of the state’s

workforce and enacted legislation to

establish an independent state council

to foster privatization efforts. These

actions, officials told us, sent a signal

to managers and employees that

political leaders were serious about

implementing privatization.

Legislative and Resource Changes
Page 13 GAO/GGD-98-87

1. Are there statutory or regulatory barriers to private sector

performance of the activity? That is:

• Are there laws, tax policies, regulations, or grant

requirements that either mandate or constrain who can

perform the activity?

• What are the implications of these legal and regulatory

requirements for a potential privatization?

2. Will there need to be a change in the statutory or regulatory

requirements to ensure a successful privatization for a

particular activity? That is:

• Is there support for such a change?

• Are the changes to laws or regulations feasible in the current

political and economic environment?

3. Are there relationships with other state or federal programs

prescribed by law that could inhibit or prohibit a change in

service providers (e.g., interservice support agreements,

intergovernmental agreements)?

4. What incentives are most appropriate for improving

performance and maximizing savings through privatization

(e.g., using savings to improve other agency activities)?

5. If there are savings from the privatization, either initially or

over the long term, how will they be distributed (e.g.,

reinvested through service improvements, tax reductions, or

deficit reduction)?

6. Under what conditions will the private sector provide

needed equipment or facilities that are not owned by the

government?

Questions Concerning Legislative

and Resource Changes
Page 14 GAO/GGD-98-87

4Complete costs are generally defined as

the fully allocated costs of an activity.

These include all direct and indirect

personnel costs, materials and supplies,

equipment, capital depreciation cost, rent,

maintenance and repairs, utilities,

insurance, personnel travel, operations

overhead, and general and administrative

overhead.

Reliable and complete cost data on

government activities are needed to

assess the overall performance of

activities targeted for privatization, to

support informed privatization

decisions, and to make these decisions

easier to implement and justify to

potential critics. Most of the

governments we surveyed used

estimated cost data, because obtaining

complete cost4

 and performance data

by activity from their accounting

systems was difficult. However,

Indianapolis and more recently Virginia

used new techniques, such as activitybased costing to obtain more precise

and complete cost data. Although the

use of estimated cost data can save a

government the time and cost

associated with preparing more

accurate data, the resulting

imprecision can have negative

consequences. For example, in

Massachusetts, the State Auditor

questioned savings reported from

privatized activities because an

inadequate cost analysis was done

before the privatization.

Reliable Cost Data
Page 15 GAO/GGD-98-87

1. Has evidence been presented on the potential for significant

enhancements to economy, efficiency, or effectiveness? That

is:

• Has a cost/benefit analysis of a possible privatization been

done, including the effects of shifting costs to service

recipients?

• Have tangible benefits--such as operating and capital cost

savings, higher quality services, more or better service

delivery options--been identified?

• Would providing potential contractors with a draft “request

for proposals” yield useful information on what cost and

service quality improvements might be possible with

privatization?

2. Have the complete costs of alternative service providers

been considered (i.e., costs of retaining the activity in-house;

cost implications of a long-term commitment; start-up and

capital investment costs; conversion costs, including the sale of

surplus property and transactional costs involved in displacing

government employees; and government costs to monitor

private sector performance)?

3. Does the relevant government office have the accounting

systems to produce complete cost data in order to make a valid

comparison to the private sector’s cost? If not, are cost

estimates acceptable for making such a comparison, and/or

would the use of activity-based costing methods be feasible on

a case-by-case basis?

4. If the private sector is unable to meet its contractual

obligations, have potential alternatives and the estimated costs

of resuming responsibility for the operation been considered?

Questions Concerning Reliable

Cost Data
Page 16 GAO/GGD-98-87

We found that governments needed to

develop strategies to help their

workforces make the transition to a

private sector environment. Such

strategies, for example, might seek to

involve employees in the privatization

process, provide training to help

prepare them for privatization, and

create a safety net for displaced

employees. For example, all six

governments developed programs or

policies to address employee concerns

with possible job loss due to

privatization. These strategies

included offering workers early

retirement, severance pay, or a buyout

or, if the activity was taken over by a

private firm, ensuring that employees’

concerns about compensation issues

were addressed.

Because Virginia found that employees’

concerns were one of the biggest

barriers to privatization, the governor

directed state officials to identify ways

for departing state workers to compete

in the private sector. This led to the

passage of the Workforce Transition

Act, which mitigated some of the

employees’ concerns, such as job loss,

training, and benefits.

Strategies for Workforce Transition
Page 17 GAO/GGD-98-87

1. What role will the government agency initially have in

considering privatization as a strategy? Will the agency be

allowed to compete with private sector firms and submit a

proposal to perform the service? If so, under what terms and

conditions? How will the competition process be coordinated

with the regular procurement process? Who will oversee the

competition process?

2. If the activity is privatized, what will be the impact on the

employment status and the portability of their pensions and

benefits? Will training be provided to government employees?

3. What will be the impact on union employees? How will the

government comply with contractual and civil service

requirements?

4. Do requirements of current labor contracts pose a challenge

to privatization? If so, what are the implications of these

requirements for the privatization, and can these contracts be

revised?

5. Will public policies, such as equal employment

opportunities, be changed if the service provider is changed

and government employees transfer to the private sector?

Questions Concerning Workforce

Transition
Page 18 GAO/GGD-98-87

When a government’s role in the

delivery of services is reduced but not

eliminated through privatization,

monitoring and oversight is needed

that evaluates compliance with the

terms of the privatization agreement

and evaluates performance in

delivering services.

Officials from all six governments

worked to enhance their employees’

skills so that they could undertake

more sophisticated especially for

complex activities, such as wastewater

treatment or the medical care of

prisoners. Monitoring performance

sometimes required new or innovative

approaches. For example, Virginia

used a newly designed approach to

measure the performance of its two

contractor-operated child support

enforcement offices. Virginia

established quarterly and semiannual

reporting requirements in the contract,

using statistical measures to compare

the performance of contractoroperated child support offices with a

hypothetical office with similarities in

such areas as size and demographics.

Monitoring and Oversight
Page 19 GAO/GGD-98-87

1. Can the government maintain necessary control and

accountability for activities that have been contracted out?

That is:

• Does the government have and will it maintain the capacity

(e.g., the expertise, staff, funding) to provide suitable

oversight of private sector performance?

• If not, can the agency recruit, attract, retain, and train

employees with the necessary knowledge and skills?

• Does the government retain the legal authority to provide

effective oversight?

2. If the activity has been divested, does the government retain

regulatory responsibilities after the divestiture?

3. Have the criteria (e.g., cost, quality, customer service,

timeliness) that will be used to evaluate the privatized activity

been defined?

4. What incentives and penalties will be used in contractual

arrangements to ensure desired performance?

5. Are performance and cost requirements specified and

measurement systems in place?

6. Does the government agency have an effective quality

control system in place, or can it be developed to determine

conformance to contractual requirements?

7. Do potential contractors have a record for effective

performance and quality control on prior projects?

8. Will there be sufficient funding to pay for oversight and

quality control?

Questions Concerning Monitoring

and Oversight
(410307) Page 20 GAO/GGD-98-87

Notes
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