United States General Accounting Office

GAO Report to the Chairman, House

Republican Task Force on Privatization

March 1997 PRIVATIZATION

Lessons Learned by

State and Local

Governments

GAO/GGD-97-48

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-271979 

March 14, 1997

The Honorable Scott Klug

Chairman, House Republican Task

 Force on Privatization

Dear Chairman Klug:

State and local governments have increased their use of privatization over

the last several years, and Congress and the administration have indicated

an interest in having the federal government also increase its use of

privatization. In light of this interest, you asked us to identify major

lessons learned by, and the related experiences of, state and city

governments in implementing privatization efforts. This report, which

responds to your request, discusses 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. Each of

these governments made extensive use of privatization over the last

several years.

Background Privatization is commonly defined as any process aimed at shifting

functions and responsibilities, in whole or in part, from the government to

the private sector. Privatization can take various forms. The most common

form is contracting, which typically entails a competition among private

bidders to perform government activities. With contracting, the

government remains the financier and has management and policy control

over the type and quality of services to be provided. Another form of

privatization occurs when a government transfers ownership of assets,

commercial type enterprises, or responsibilities to the private sector. This

is called an “asset sale,” and generally the government would have no role

in the financial support, management, or oversight of a sold asset.

Another, more recent variation of privatization is “managed competition.”

Under it, the contracting process permits an agency (e.g., the highway

department) of the government to prepare a work proposal and submit a

bid to compete with private bidders (e.g., highway construction

contractors). The government may award the contract to the bidding

agency or to a private bidder. (App. I shows various forms of privatization

and the frequency of their use by state governments as reported by the

Council of State Governments in 1993.)

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Over the past several years, state and local governments have increased

their use of various types of privatization. The 1993 Council of State

Governments’ survey found that state agencies responsible for social

services, transportation, mental health care, corrections, health, and

education had all increased privatization activities since 1988. The Council

reported that the survey results indicated a trend toward expanded

privatization across major state agencies.1

 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.2

Recent federal laws, rules, and initiatives—especially the Government

Performance and Results Act of 1993 (GPRA);3

 the Clinger-Cohen Act of

1996;4

 the revised handbook to Office of Management and Budget (OMB)

Circular A-76;5

 and the Clinton Administration’s major management reform

initiative, the National Performance Review (NPR)—have given new

impetus to federal agencies to operate more effectively and efficiently.

One helpful approach in reaching this goal, according to NPR, is

privatization. Certain of the cited laws and initiatives direct federal

managers to review their programs by first considering whether

government should be performing an activity, a step that can lead to

privatization.

1

State Trends and Forecasts: Privatization, Vol. II: No. 2 (Lexington, KY: November 1993).

2

International City/County Management Association Municipal Year Book 1994: Alternative Service

Delivery in Local Government, 1982-1992 (Washington, D.C.: 1994), p. 28.

3

GPRA requires agencies to develop strategic plans, obtain input on desired goals from key

stakeholders, and measure and report progress toward achieving those goals.

4

The Clinger-Cohen Act was originally the Federal Acquisition Reform Act of 1996 and the Information

Technology Management Reform Act (ITMRA) of 1996. It was renamed by section 808 of Public Law

104-208, enacted on September 30, 1996. ITMRA introduced new requirements for how information

technology-related projects are to be selected and managed. These requirements closely parallel

investment practices of leading organizations.

5

OMB Circular A-76 sets forth federal policy for using commercial services. In March 1996, OMB

revised the A-76 supplemental handbook to enhance federal performance through competition and

choice, seek the most cost-effective means of obtaining commercial products and support services,

and provide new administrative flexibility in agencies’ decisions to retain services in-house or contract

them out.

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Results in Brief The six governments we visited tailored their approaches to privatization

to their particular political, economic, and labor environments.6

 On the

basis of our literature review, the views of a panel of privatization experts,

and our work in the six governments, we identified six lessons learned, as

shown in figure 1, that were generally common to all six governments in

implementing privatization initiatives.

6

The predominant form of privatization that occurred in these six governments was contracting for

goods and services, followed by asset sales and managed competitions.

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Figure 1: Lessons Learned From Our Review of State and Local Privatization Efforts

Reliable cost data

Reliable cost data on

 government activities

 are needed to support

 informed privatization

 decisions and to assess

 overall performance.

Political champion 

Privatization can best be introduced

 and sustained when a political 

 leader champions it.

Implementation structure

Government leaders need to

 establish an organizational

 and analytical structure to ensure

 effective implementation.

Legislative and

resource changes

Governments may need to

 enact legislative changes

 and/or reduce governmental

 resources to encourage

 greater use of privatization.

Strategies for 

workforce transition

Governments need

 strategies to manage

 workforce transition.

Monitoring and oversight

More sophisticated

 monitoring and oversight

 are needed to protect the

 government's interests

 when its role in the delivery

 of services is reduced

 through privatization.

Implementation

Source: GAO analysis.

First of all, privatization can best be introduced and sustained when there

is a committed political leader to champion it. In the six governments, a

political leader (the governor or mayor), or in one case several leaders

working in concert (state legislators and the governor), played a crucial

role in introducing privatization. These leaders built internal and external

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support for privatization, sustained momentum for their privatization

initiatives, and adjusted implementation strategies when barriers to

privatization arose.

Second, 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. For example, five of the six governments established

governmentwide commissions to identify privatization opportunities

among government activities and to set policies to guide privatization

initiatives.

Third, 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, enhanced privatization and sent a signal to

managers and employees that political leaders were serious about

implementing privatization.

Fourth, 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 cost7

 and performance data by activity from their accounting

systems was difficult. However, Indianapolis and more recently Virginia

used new techniques to obtain more precise and complete cost data. While

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.

Fifth, governments need 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,

7

Complete costs are generally defined as the fully allocated costs of an activity. These include all direct

and indirect personnel costs, as well as the costs of materials and supplies, equipment, capital

depreciation, rent, maintenance and repairs, utilities, insurance, personnel travel, operations overhead,

and general and administrative overhead.

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provide training to help prepare them for privatization, and create a safety

net for displaced employees. Among the six governments we visited, four

permitted at least some employee groups to submit bids along with

private-sector bidders to provide public services. All six governments

developed programs or policies to address employee concerns with

privatization, such as job loss and the need for retraining.

Finally, when a government’s direct role in the delivery of services is

reduced through privatization, a need is created for enhanced monitoring

and oversight that evaluates compliance with the terms of the privatization

agreement and evaluates performance in delivering services to ensure that

the government’s interests are fully protected. For example, Indianapolis

officials said their efforts to develop performance measures for activities

enhanced their monitoring efforts. However, officials from most

governments said that monitoring contractors’ performance was the

weakest link in their privatization processes.

Objective, Scope, and

Methodology

Our objective was to ascertain the lessons learned by, and the related

experiences of, state and local governments in privatizing government

activities. To meet this objective, we went through a multistep process to

identify the governments to survey, developed an information collection

framework refined with the assistance of a panel of experts, and then

contacted various officials from the selected governments to obtain

information and insights on their privatization experiences.

To develop a list of potential states and cities to survey, we first surveyed

50 individuals whom we identified as knowledgeable on privatization

topics from congressional testimony, studies, and other published

literature on the privatization of government activities. We asked the 50

individuals to name states and cities that had undertaken notable

privatization efforts, and 33 of the individuals responded. From their

responses, we compiled a list of 10 state governments and 10 city

governments that the respondents had named most often as undertaking

notable privatization efforts.

As agreed with your office, we focused the rest of our selection process on

state governments rather than city governments. We focused on states

because data indicated that states were generally involved in privatizing a

wider variety of activities than were cities, and because lessons learned by

state governments would be more likely than local government

experiences to be instructive in the federal context. However, as agreed

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with your office, we included the city of Indianapolis in our survey

because it was cited more frequently than any other city or state named by

our experts.

A panel of 8 privatization experts reviewed our list of state governments

and agreed that the 10 state governments and Indianapolis were the most

appropriate candidates to survey. The panel members, most of whom were

drawn from among the 33 respondents to our survey, are listed in

appendix II. They were selected on the basis of their practical knowledge

of privatization or their scholarly knowledge on the issue of privatization.

We contacted the 10 state governments to update privatization data that

were reported on them and other states in a 1993 Council of State

Governments report. On the basis of information in the 1993 report and

the updated data from the 10 states, we selected Georgia, Massachusetts,

Michigan, New York, and Virginia for visits and further research. We chose

these states because they had the most extensive privatization efforts

involving activities that correlate with those performed at the federal level.

Their privatization efforts, and those of Indianapolis, covered a variety of

mission-related activities, such as prison health care, delinquent tax

collection, and vehicle maintenance.

Before meeting with various officials from the six governments, we

developed from the relevant literature a list of key privatization factors

that our panel of eight experts agreed were critical or important when

considering whether to privatize public functions. These factors gave us a

framework for collecting information on privatization experiences. We

pretested this framework and data collection approach and made minor

adjustments.

Using our framework of privatization factors as a guide, we interviewed,

and obtained documents from, 117 officials in the 6 sites that we visited.

These included policymakers (such as cabinet officers and directors of

privatization offices), agency managers, and labor representatives who

were involved with or knowledgeable about the privatization efforts of the

six governments. To obtain an independent perspective, we interviewed

audit and legislative oversight officials who had knowledge of their

governments’ privatization efforts. We obtained from these various

officials information on such topics as (1) the reasons for using

privatization; (2) approaches taken to introduce, implement, and manage

privatization efforts; and (3) barriers to privatization and strategies

employed to overcome the barriers. In our interviews and document

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reviews, we focused attention on privatization efforts that occurred since

1991, were reported to have had high cost savings, were reported to have

resulted in continued or improved service, and involved activities similar

to those performed by the federal government.

In addition to our interview data, we reviewed such state, city, and agency

documents as commission reports, planning documents, policy and

procedural guidance, budget documents, legislative analyses, agency

performance reports, audit reports, and pertinent legislation. From our

analysis of the information obtained, we distilled a list of major lessons

learned in privatizing state and local government activities. The list was

not intended to be an exhaustive compilation of all possible or actual

lessons learned or experiences in privatizing government activities.

Because our objective was to identify lessons learned by the six

governments we visited, we relied on their own evaluations and

assessment of their experiences. Using information they gave us, we

summarized a number of the six governments’ privatization projects that

they selected (see app. III). We did not evaluate privatization results or

independently verify the accuracy of the information provided by the

governments. Because this report uses a wide variety of privatization

terms, we also prepared a privatization glossary so that the types of

privatization we refer to in this report can be understood in the context of

the range of privatization efforts that can occur. The glossary appears at

the end of the report.

We did our work at the selected states’ capitals, Indianapolis, and

Washington, D.C., from April 1996 through December 1996 in accordance

with generally accepted government auditing standards. In February 1997,

we provided the chief executives of the six governments with a draft of

this report for review and comment. These governments concurred with

the message of our report and provided clarifying comments, which we

have included where appropriate.

Privatization Requires

a Political Champion

According to our panel of experts and officials of the six governments we

surveyed, privatization can best be introduced and sustained when a

political leader champions it. The panel and officials said that, in

introducing and sustaining privatization initiatives, political leaders should

anticipate a need to develop and communicate a privatization philosophy

and to garner public, business, and political support.

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According to the government officials that we interviewed, the chief

executive (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. The political

champions faced a variety of political and economic environments. In

some cases, the political leaders introduced and built support for

privatization within government workforces that were unionized and, in

other cases, within workforces that were not unionized. Similarly, some

political leaders introduced and built support for privatization during

times when their respective governments were experiencing fiscal

problems, and other leaders did so during times when their governments

were stable financially. For example, the Governor of Massachusetts

introduced privatization during a period when the state, which had a

heavily unionized workforce, was experiencing a severe budget crisis. On

the other hand, Virginia’s leaders introduced privatization into a largely

nonunionized workforce and saw it as an approach that could help the

state government more effectively deliver services and maintain its sound

fiscal condition.

While forceful leadership was reported to be an important ingredient in

the success of privatization initiatives by the six governments, they also

came to recognize a need for flexibility. When implementing privatization,

political leaders found that they could encounter barriers that might

require them to adjust their privatization strategy to maintain support. For

example, when Indianapolis’s initiative encountered early opposition from

employee unions, the Mayor began formally involving the unions in the

privatization process. In doing so, he moved from an approach that solely

emphasized competing public activities among private-sector firms to one

that included using managed competition, which gave city employees the

chance to compete with the private sector. This change in approach,

according to city and union officials, won employee support and allowed

the privatization initiative to proceed.

According to Indianapolis officials, competition in the marketplace rather

than privatization per se produces the most value for the taxpayer. This

view was shared by most state officials we spoke with. A top Indianapolis

official said that the primary advantages of managed competition were

reduced costs, improved services, improved employee morale, and

increased innovation. Massachusetts, New York, and Virginia now permit

government agencies to bid on certain contracts that are open to the

private sector.

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Implementation

Structure Needed to

Guide Privatization

Efforts

According to officials in the six governments, once political leaders

introduce privatization, they need to establish a formal structure to ensure

effective implementation. Such a structure can include a governmentwide

commission to identify privatization opportunities and set privatization

policy, a staff office that can support agencies in their privatization efforts

and oversee implementation, and a framework for making privatization

decisions.

Five of the six governments used governmentwide commissions to

promote privatization, identify privatization opportunities, and establish

policies and procedures to guide privatization initiatives. Massachusetts

did not use a commission; instead, cabinet secretaries selected the

government activities to privatize. The commissions were created either

by the chief executive (Georgia, Michigan, New York, and Indianapolis) or

jointly by the state legislature and chief executive (Virginia).

The memberships of the four state commissions included representatives

of both government and the private sector. Indianapolis’s commission was

composed of private sector representatives, assisted by both private and

public-sector employees. Although officials in the five governments saw

commissions as useful, a former senior official from Michigan who studied

his and other states’ commissions8

 cautioned that a commission’s

effectiveness can be limited if it does not have a clear mission and a

membership that reflects a balance between the public and private

sectors.

Five of the six governments established offices or support staffs, which

were attached to the privatization commissions, to provide guidance and

technical assistance to agencies in the day-to-day implementation of

privatization.9

 New York’s office, the Empire State Development

Corporation, was unique among the supporting organizations in that it was

a government corporation. Massachusetts did not establish a separate

support office. Instead, individual departments initially used internal

teams to design and implement specific initiatives. Later the Executive

Office for Administration and Finance provided guidance to departments.

8

John M. Kost, New Approaches to Public Management: The Case of Michigan (Washington, D.C.: The

Brookings Institution, July 1996).

9

Michigan established a Privatization Division as part of its Department of Management and Budget in

1991, before the governor established a public-private partnership commission in 1992. The

Privatization Division provided staff support to the commission before the commission was abolished

in late 1992.

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These support units, according to officials and documents we reviewed,

typically used an analytical framework to evaluate the costs and

performance of government activities and the risks and benefits of

privatizing a particular activity. These analytical frameworks typically

included a step-by-step decisionmaking process. Having a framework that

provides a consistent approach for analyzing government activities was

considered highly desirable by key officials in all six governments. Many

of the frameworks established by the six governments shared common

elements such as providing criteria for selecting activities to privatize, an

inventory of privatization candidates, cost comparison and evaluation

methods, and procedures for monitoring the performance of privatized

activities. The frameworks used by Michigan, Virginia, and Indianapolis

are described in more detail in appendix IV.

Legislative and/or

Resource Changes

May Be Needed to

Promote the Use of

Privatization

According to some officials, governments may need to enact legislative

and/or resource changes to encourage or facilitate the use of privatization.

These changes, the officials said, are necessary to signal to managers and

employees that the move to privatization is serious and not a passing fad.

All five states and the city of Indianapolis used some combination of

legislative changes and resource cuts as part of their privatization

initiatives. For example, Virginia enacted the Virginia Government

Competition Act of 1995, which created a permanent independent state

council to promote privatization. The state also initiated an effort to

reduce its workforce by 15 percent over 3 years. According to state

officials, some departments, such as transportation, began facing work

backlogs following this reduction. To ease this backlog, Virginia looked to

the private sector to perform the work. Virginia officials said enabling

legislation and staffing cuts together signaled the seriousness of Virginia’s

effort to increase the use of privatization and managed competition.

Georgia’s legislature, with the Governor’s support, passed civil service

reform legislation that made it easier for the state to hire and fire

employees. Georgia officials told us that this measure facilitated the use of

privatization by state managers. In addition, the Governor instituted a

budget redirection program in 1996 that required all agencies to prioritize

their current programs and activities and identify those programs that

could be eliminated or streamlined to the extent that the agencies would

be able to make at least 5 percent of their total state-funded budgets

available to be redirected to higher priorities. Each agency was asked to

recommend how the 5 percent would be redirected to existing programs

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or to new programs within the agency. According to the Executive

Director of Georgia’s Commission on Privatization, the Governor, as part

of his budget development process, reviewed these recommended

redirections, as well as other statewide priorities, and shifted those

identified funds within and among the agencies as determined to be most

cost beneficial. This budget redirection initiative, according to the

Executive Director, will continue for the remainder of the Governor’s

term, which ends in early 1998. According to a Georgia Privatization

Commission official, agencies were given a 6-month notice that their

budgets would be cut. State officials said these cuts required managers to

rethink how they could perform the same activities for a lower cost. This

led to contracting out more activities, such as vehicle maintenance and

management services for a war veterans facility.

In Indianapolis, the Mayor eliminated selected middle-level management

positions. According to the remaining supervisors with whom we spoke,

this action sent a clear message that the city’s privatization program was

serious and that the city workforce would have to work differently and use

new methods if it were to successfully compete to retain city work. Union

officials said that these selective management cuts helped to build union

support for the competition initiatives.

Reliable and

Complete Cost

Information Needed

to Support

Privatization

According to officials in the six governments and our panel of experts,

reliable and complete cost data on government activities are needed to

ensure a sound competitive process and to assess overall performance.

Reliable and complete data, they said, simplify privatization decisions and

make these decisions easier to implement and justify to potential critics.

All six governments developed information on the cost of government

activities. Four governments made “best estimates” of a service’s or

function’s cost because obtaining complete cost and performance data by

activity from their accounting systems was difficult. Indianapolis and

Virginia attempted to go beyond best estimates by making extensive

efforts to identify all costs associated with performing a government

function or service.

Indianapolis was nationally recognized for using an activity-based costing

(ABC) approach. Indianapolis used this approach to help analysts derive

the complete costs of providing a service or performing a function.

Following ABC procedures, analysts were to identify all activities

associated with producing a service or function and to evaluate the

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resources these activities consumed to achieve various levels of

performance.

Virginia introduced a comprehensive cost analysis method based on the

federal government’s A-76 program and the state’s contracting experiences

to try to capture the complete costs associated with performing a service

or function. Virginia reported that in fiscal year 1996 it was able to identify

complete costs for 45 percent of the government activities identified as

privatization candidates. Since 1995, Virginia has piloted an ABC approach

in a number of agencies as a possible replacement for its existing analysis

method. According to officials in Indianapolis and Virginia, obtaining more

complete data was more time consuming but enhanced their governments’

ability to identify cost savings and evaluate bid proposals.

Indianapolis officials told us they were able to obtain the information they

needed to do ABC analyses from their current accounting system even

though it did not provide cost data by activity. Officials used a system that

took cost data (e.g., salaries, overhead) associated with a function (e.g.,

street maintenance) and assigned it for cost analysis purposes to activities

(e.g., filling potholes, cleaning streets, repairing curbs). The city was

assisted in this exercise by a private-sector firm with cost-analysis

expertise.

Indianapolis and Virginia officials also said that working before

privatization occurs with private firms with expertise in an activity slated

for privatization was very beneficial in getting a better understanding of

the cost and performance issues likely to be encountered during a

privatization. For example, when Virginia’s Department of Corrections

planned its prison privatization project, the department publicly discussed

its plans with private firms to better understand the issues that needed to

be addressed and resolved in order to successfully privatize prisons.

According to the Director of Virginia’s Commonwealth Competition

Council, after the department consulted with private firms, it better

understood what the needs of the private sector were in terms of writing

specific statements of work and better realized the potential cost-benefit

to the state of the proposed prison privatization.

Attaining precision in cost data has tradeoffs, according to a number of

government officials that we interviewed. In general, while cost estimates

can be made more quickly and at less cost than more precise approaches

such as ABC, their use also may have negative consequences. For example,

Massachusetts, according to senior state administration and audit officials,

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used estimates because complete cost data on state activities were

difficult to obtain from the state’s accounting system. However, reports by

the Massachusetts State Auditor called into question the reported savings

of some privatization activities, citing inadequate cost analysis before

privatization as well as a lack of substantiating data on the benefits

claimed following privatization.

Strategies Needed to

Manage Workforce

Transition

According to most officials in the six governments and our expert panel,

moving governments into privatization requires (1) employee involvement

in the privatization process, (2) training to provide skills for either

competing against the private sector or monitoring contractor

performance, and (3) creating a safety net for displaced employees. Most

officials said these strategies were necessary to mitigate employees’

concerns with, and to bolster their support for, the privatization changes

as well as to aid in the transition to a competitive environment.

All six governments developed workforce transition strategies to

complement their privatization efforts. These strategies varied depending

on local political factors and the relationship between the governments’

top leaders and employee groups.

Employee Involvement In the six governments, management of employee involvement in the

privatizations was not only important to initial efforts but also set the tone

for future privatizations. For example, Massachusetts officials said that

their initial failure to involve state employee unions in their privatization

plans led the unions to contest and block these plans. State officials said

that following this initial confrontation, Massachusetts sought to improve

labor-management cooperation by allowing unions to compete for several

highway maintenance contracts. Nevertheless, according to state officials,

union and state legislature concerns that employee protections were not

being observed under privatization contributed to the passage of

legislation in 1993, over the Governor’s veto, that made privatization more

difficult.10 For example, the law required private firms that win state

contracts to offer jobs to qualified state employees who were terminated

because of the contracts and to compensate them at a rate comparable to

their government pay and benefits. The Massachusetts State Auditor said

that in the 2 years before the law, 6 Massachusetts departments privatized

approximately 20 services, but only 2 privatizations occurred between the

law’s enactment and December 1996.

10Commonwealth of Massachusetts Privatization Law, Chapter 296 of the Acts of 1993.

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According to privatization experts, Indianapolis presents a comprehensive

example of how a government benefited by engaging employees and their

unions in the privatization process. Indianapolis’s management employees

were involved in the privatization process when it began but union

employees were not formally involved. Soon after introducing

privatization, the Mayor moved to address employee concerns raised by

unions about not being formally involved in the city’s privatization efforts.

According to city and union officials, the city used a multifaceted

approach to effectively address the unions’ concerns. This approach

included the use of new management tools (such as ABC), training in use of

the tools, a cooperative union-management effort, and permitting and

enabling the workforce to compete against private vendors. This

cooperative effort, we were told, was built on (1) empowering frontline

workers to make decisions and act on their own initiative, (2) providing

training and pay incentives for performance, (3) fostering a partnership

with unions, and (4) establishing an employee safety net for displaced

workers.

Training The majority of the top government officials and experts whom we

surveyed said that having qualified employees with specific skills related

to privatization was important to successfully implementing privatization.

However, some officials said the need for new skills should not impede

privatization since the skills could also be contracted for if not available

within the government workforce.

Officials from the states and Indianapolis pointed out that to move into a

more competitive environment, their governments had to improve the

skills of their employees so they could (1) participate in managed

competition and/or (2) prepare for and monitor contracting efforts. Public

and union officials identified the following as helpful to employees

involved in privatization: (1) knowledge of the existing government

program, (2) ability to analyze work flows and processes, (3) ability to

develop methods to eliminate inefficiencies, (4) knowledge of

cost-estimation techniques, (5) ability to apply methods of financial

analysis, (6) ability to determine and write concise and specific contract

requirements to delineate exactly what the contractor is responsible for,

and (7) knowledge of methods for monitoring the performance of

contractors.

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Safety Net Providing a safety net for displaced workers was a component of the six

governments’ workforce transition strategies. 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 involved in this transition were

addressed.11 Other strategies included placing workers in other

government units if their jobs were eliminated and offering job transition

assistance, such as career planning and training, to workers moving to the

private sector. According to Virginia officials, for example, employees’

concerns were one of the biggest barriers in that state’s privatization

efforts. The Governor directed state officials to examine and recommend

measures to provide the opportunity for departing state workers to

compete in the private sector. According to state officials and employee

representatives, this led to the passage of the Workforce Transition Act,

which mitigated some of the employees’ concerns with privatization, such

as job loss, training, and benefits.

In New York, according to state officials, new collective bargaining

agreements were negotiated that allowed the state to lay off affected

employees, provided they were accorded certain considerations such as 60

days written notice of intended separation, placement on a redeployment

list, and an offer of redeployment if a fillable vacancy became available

elsewhere in state government. If redeployment was not possible and the

employee had no displacement rights under the state’s Civil Service Law,

the employee had the option of receiving a financial stipend for an

identified retraining or educational opportunity, severance pay, or

preferential consideration for employment with the contractor.

Redeployment would ensure that the affected employees maintained their

salary and titles comparable to former positions.

Enhanced Monitoring

and Oversight of

Performance Is

Needed When

Privatization Is Used

According to officials with the six governments, monitoring and oversight

that not only evaluates compliance with the terms of the privatization

agreement but also evaluates a private firm’s performance in delivering

services is needed when a government’s direct role in the delivery of

services is reduced through privatization. This is necessary to help ensure

that the government’s interests are protected and that accountability of

both the government and the private party is maintained.

11To the extent that resources are provided by a government for services such as severance pay or

training, the net financial savings resulting from the privatization may be diminished.

Page 16 GAO/GGD-97-48 Privatization Lessons Learned
B-271979 

Monitoring Privatization Officials in all six governments told us that monitoring of privatized

activities is critical. According to experts, such monitoring consists of

contract auditing and technical or performance monitoring. Contract

auditing aims to ensure that contractors are paid as mandated by the

contract and that all contractual obligations are fulfilled. Contract auditing

also serves as an independent check on contractors and on the

government’s contract managers. Technical and/or performance

monitoring aims to ensure that contractor-provided services are meeting

contract specifications for quantity and quality.

The majority of the state and city officials we interviewed said that

performance monitoring is more difficult than contract auditing and that

their governments faced a much greater need to develop employee skills

for performance monitoring than for contract auditing. Officials at all of

the governments we visited said that one of the most important—and

often most difficult—tasks in privatizing government activities was writing

specific work statements for the privatization contracts. Officials noted

that when contract requirements were vague, contractor performance was

not easily evaluated, even if the government used sufficient and effective

monitoring techniques. Given the importance of being able to specify work

requirements and outputs, most of the six governments reported that they

took steps to mitigate their risk. For example, Georgia and Virginia’s

guidance for evaluating whether a service should be considered for

privatization focused on the ease with which the service’s objectives could

be defined and measured for monitoring purposes. Indianapolis officials

said that its use of performance measures enhanced the writing of

contract terms because they focused at the activity level (e.g., air and

water quality assurance) and measured each activity’s outputs (e.g., water

samples collected and evaluated).

Officials from all but Indianapolis said that performance monitoring was

their weakest link in the privatization process. Officials from all the

governments said that they were working to enhance their employees’

skills so that they could undertake more sophisticated monitoring. For

example, officials said that monitoring the performance of complex

activities, such as wastewater treatment or the medical care of prisoners,

can require analytical skills that go beyond compliance checklist-type

reviews. Monitoring performance, they said, 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. Because the offices were newly created,

Virginia could not compare pre- and post-privatization costs. Instead,

Page 17 GAO/GGD-97-48 Privatization Lessons Learned
B-271979 

Virginia established quarterly and semiannual reporting requirements in

the contract and used sophisticated statistical measures to compare the

performance of its child support offices with a hypothetical average office

with similar characteristics, such as size and demographics. In addition to

having performance measures, the new system required new data

collection skills for state employees, such as doing customer satisfaction

surveys.

Oversight of Privatization Officials in all six jurisdictions and our expert panel told us that

independent oversight of privatization efforts was critical. Independent

oversight by an office that is outside the control of the unit responsible for

operating the activity provides a more objective and unbiased evaluation

of privatized activities than is possible by senior government managers or

program-level monitors. Virginia’s Auditor of Public Accounts, for

example, said that independent oversight can focus on such areas as

automatic contract extensions to ensure that costs do not escalate without

limit and that the program manager attempts to maximize competition in

the award of contracts.

Each of the six governments had independent oversight functions, and

these functions played different roles in the privatization process and

provided varying degrees of oversight coverage. For example, beginning in

December 1993, the Massachusetts State Auditor had formal review and

approval powers related to proposed privatizations for activities costing

over $100,000. Virginia’s legislative and executive branches, according to

officials of both branches, provided extensive oversight. In the executive

branch, Virginia had an agency network of internal auditors, coordinated

by the Department of the State Internal Auditor, to review privatized

activities within their respective agencies. Virginia’s legislature had the

Joint Legislative Audit Review Commission (JLARC) and the Auditor of

Public Accounts. JLARC’s actions on a proposed privatization demonstrate

the value of independent oversight. In 1996, JLARC raised concerns about a

proposed computer systems privatization that was begun before the state

government established its current privatization process. As a result of

these concerns, the General Assembly subsequently delayed the proposed

privatization and directed JLARC to conduct a more complete study of the

project.

We are sending copies of this report to the Chairman and Ranking

Minority Member of the Senate Committee on Governmental Affairs and

Page 18 GAO/GGD-97-48 Privatization Lessons Learned
B-271979 

the House Committee on Government Reform and Oversight; the Director,

Office of Management and Budget; the Director, Office of Personnel

Management; and other interested parties. Copies will be made to others

upon request.

The major contributors to this report are listed in appendix V. Please

contact me on (202) 512-9039 if you have any questions.

Sincerely yours,

Michael Brostek

Associate Director, Federal Management

 and Workforce Issues

Page 19 GAO/GGD-97-48 Privatization Lessons Learned
Contents

Letter 1

Appendix I 

Forms of Privatization

and Frequency of Use

in State Programs and

Services

22

Appendix II 

Expert Panelists on

GAO’s Review of State

and Local

Privatization Efforts

24

Appendix III 

Overview of Recent

Privatization Efforts

in the Six

Governments

25

Appendix IV 

Analytical

Frameworks Used by

Indianapolis,

Michigan, and Virginia

34

Appendix V 

Major Contributors

and

Acknowledgments

43

Page 20 GAO/GGD-97-48 Privatization Lessons Learned
Contents

Glossary of

Privatization-Related

Terms

44

GAO Privatization

Products Related to

State and Local

Governments

48

Figures Figure 1: Lessons Learned From Our Review of State and Local

Privatization Efforts

4

Figure IV.1: The Indianapolis Approach: Costing and

Competitiveness in the Delivery of Public Services

36

Figure IV.2: Michigan’s PERM Process for Analyzing Functions

and Services

39

Figure IV.3: Virginia’s Commonwealth Competition Council

Process

42

Abbreviations

ABC activity-based costing

CCC (Virginia) Commonwealth Competition Council

CEO chief executive officer

DMB (Michigan) Department of Management and Budget

ESOP employee stock ownership plan

GPRA Government Performance and Results Act of 1993

GSE government-sponsored enterprise

ITMRA Information Technology Reform of 1996

JLARC (Virginia) Joint Legislative Audit Review Commission

NPR National Performance Review

OMB Office of Management and Budget

PBO performance based organization

PERM (Michigan) privatize, eliminate, retain, or modify

Page 21 GAO/GGD-97-48 Privatization Lessons Learned
Appendix I 

Forms of Privatization and Frequency of

Use in State Programs and Services

Forms of privatization

Administration/

General Services Corrections

Contracting out 91.67% 92.09%

Grants 0.56 1.19

Vouchers 3.06 0.40

Volunteerism 1.39 3.56

Public-private partnerships 1.67 2.37

Private donation 0.56 0.40

Franchise 0.28 .00

Service shedding 0.28 .00

Deregulation .00 .00

Asset sales 0.56 .00

Page 22 GAO/GGD-97-48 Privatization Lessons Learned
Appendix I 

Forms of Privatization and Frequency of

Use in State Programs and Services

Agencies’ frequency of use

Education Health

Mental Health/

Retardation Social Services Transportation

Average by form of

privatization

81.29% 69.57% 64.67% 71.32% 83.51% 78.06%

8.63 14.13 15.63 12.48 4.50 8.48

0.72 4.89 5.35 9.31 0.43 4.11

1.44 3.26 3.64 2.98 5.35 3.32

5.04 5.43 3.85 2.23 2.57 2.95

0.72 .00 2.57 0.19 1.28 0.96

1.44 1.09 1.71 0.37 1.50 0.91

0.72 1.09 0.86 0.74 0.43 0.58

.00 0.54 1.50 0.37 0.21 0.46

.00 .00 0.21 .00 0.21 0.17

Source: State Trends and Forecasts: Privatization, Council of State Governments, 1993.

Page 23 GAO/GGD-97-48 Privatization Lessons Learned
Appendix II 

Expert Panelists on GAO’s Review of State

and Local Privatization Efforts1

Keon S. Chi, Director, Center for State Trends and Innovations, Council of

State Governments. Author, State Trends and Forecasts: Privatization,

1993, and Privatization and Contracting Out for State Services: A Guide,

1988, The Council of State Governments.

John D. Donahue, Professor, John F. Kennedy School of Government,

Harvard University. Author, The Privatization Decision: Public Ends,

Private Means, 1989.

William D. Eggers, Director of Privatization and Government Reform,

Reason Foundation. Coauthor, Revolution at the Roots: Making Our

Government Smaller, Better, and Closer to Home, 1995.

David Seader, Senior Manager, Privatization and Infrastructure Group,

Price Waterhouse. Former Executive Director, Privatization Council, Inc.,

a nonprofit educational organization devoted to developing and expanding

the concept of privatization and public-private partnerships.

Dennis Houlihan, Labor Economist, Department of Research and

Collective Bargaining Services, American Federation of State, County, and

Municipal Employees.

Ronald W. Jensen, Private Consultant. Former Public Works Director,

Phoenix, Arizona. Developed city program on privatization; specifically

initiated the innovative process of various city operations competitively

bidding against private contractors.

Linda Morrison, Private Consultant. Former Director of the Mayor’s

Competitive Contracting Office, Philadelphia, Pennsylvania, and former

competitive contracting advisor to the State of New Jersey.

Larry Gupton, Deputy Auditor, State of Colorado. Coauthor of

Privatization in Colorado State Government: Performance Audit, 1989, and

the follow-up performance audit report, 1993.

1

 The panel helped us identify governments to visit and validated our framework of privatization

factors, which we used as a guide in data collection.

Page 24 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

This appendix provides an overview of selected recent privatization efforts

in the six governments we surveyed. Officials from the six governments

provided the following key initial actions, primary reasons for

governmentwide privatization efforts, and an overview of select projects.

Page 25 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Government Key initial action

Primary reasons for governmentwide

privatization efforts

Georgia Governor created commission on privatization of

government services in 1995.

Limit growth of government. 

Reduce scope of government. 

Improve government efficiency.

Massachusetts Governor called on department managers to privatize

functions and services in 1991.

Reduce state budget deficit.

Reduce costs of government services.

Improve quality of government services.

Page 26 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Overview of governments’ select projects

Project Primary reason

Type of

privatizationa Reported resultsb

Milledgeville War

Veterans 

Home

Privatization Commission

analysis showed that costs

were much higher than in

six benchmark states.

Outsourcing • Estimated cost savings of 57 percent for 5 years. 

• Staff are more responsive to family concerns and

 inquiries. 

• Quality of life enhancements include: cleaner home,

 better food, and cable television. 

State maintenance 

of autos

Not a core function of state. Outsourcing • Estimated cost savings of $300,000 per year. Estimated

 savings represent a projected 40 percent savings over

 government provision of service.

Lake Lanier Islands

recreational area

Not a core function of state. Outsourcing • Projected revenue of $300 million to $350 million over

 the 50-year contract.

Prison health care Reduce prison health care

costs and improve medical

care and access to care.

Outsourcing • Estimated annual cost savings of $8 million over 5-year

 contract.

• Expenses for state employee benefits have been

 reduced.

• State shielded from liability because single vendor has

 become responsible for all inmate patient care and

 held responsible for all malpractice awards and legal

 costs.

• Ten of 20 state prisons now meet National Commission

 on Correctional Health Care accreditation standards

 (previously none of the prisons met these standards).

• Trips by prisoners to outside hospitals have been

 reduced from over 100 every day to 100 per week.

 This has reduced personnel and transportation costs.

Essex County

highway

maintenance

Improve quality of highway

maintenance.

Outsourcing/

managed

competition

• Dollar savings from the first year of the contract were $2

 million in direct operating costs, $1 million in

 reallocated equipment, and $1.5 million in

 reallocated personnel.

• Maintenance overtime costs reduced by $252,000 in the

 first year of the contract.

• Highway maintenance services have improved and

 include new bridge washing service, increased

 mowing of grass, roadway sweepings, and

 guardrail maintenance.

Social services

revenue

management

operations

Apply private-sector

technology to increase

revenue collections.

Outsourcing • Overall increase in collections of $87 million during

 first 2 years of contract (federal fiscal years 1994 and

 1995).

• Before privatization an estimated $49 million to $70

 million was not collected annually.

• Agency has increased its annual level of revenue

 generation by 40 percent and reduced its per-dollar

 cost of revenue collection by 30 percent.

• Additional revenue has been used to boost the

 agency’s preventive services, adoption, foster care

 and other child welfare initiatives.

(continued)

Page 27 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Government Key initial action

Primary reasons for governmentwide

privatization efforts

Michigan Governor created public-private partnership

commission in 1992.

Reduce the state’s budget deficit.

Shrink size and scope of government.

New York Governor established an advisory commission on

privatization and a research council on privatization in

1995.

Reduce size and scope of government. 

Reduce cost and improve the quality of

government services.

Page 28 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Overview of governments’ select projects

Project Primary reason

Type of

privatizationa Reported resultsb

Workers

Compensation

Accident Fund

State determined that the

fund should no longer be a

government function.

Asset sale • The state gained $261 million from the sale of the

 Accident Fund.

• The private Accident Fund Company has reduced rates

 by an average of 9.2 percent in the first year of

 operations. 

• Quality service at competitive rates.

• Removes potential for political interference in the

 ratemaking process.

• The private Accident Fund Company has introduced

 new products for participants, such as group

 dividend programs which offer the potential for

 rebates on insurance premiums if the overall loss ratio

 for the group remains low.

Physical security at

military facilities

Cost savings. Outsourcing • Estimated savings of approximately $1.2 million over

 fiscal year 1996 costs from contracting security

 programs at Camp Grayling, Alpena Combat Center,

 and Battle Creek Air National Guard Base. 

• Estimated cost savings represent a savings of 70

 percent over fiscal year 1996 costs. 

• Allows the state’s Department of Military Affairs to meet

 federal security requirements at all three sites within

 the limitations of available federal funding.

• Camp Grayling increased level of security with

 enhanced monitoring coverage.

Sales of armories Excess, unused armories

that resulted from national

defense downsizing were

no longer needed.

Asset sale • State gained $407,900 from the sale of the St. Joseph

 and Benton Harbor armories. 

• Sale proceeds from armory asset sales deposited in

 Michigan National Guard Armory Construction Fund

 to be used for acquisition and construction of facilities

 and other purposes, thereby offsetting future1

 general fund expenditures. 

• State no longer responsible for oversight of vacant

 facilities.

Vista Hotel Owning/operating hotel

was not considered

to be a governmental

function.

Asset sale • Hotel was sold in 1995 by the New York-New Jersey

 Port Authority for $141.5 million.

Tax form processing To enhance cost savings

and the efficiency and

effectiveness of processing

tax returns.

Outsourcing • Estimated annual savings of $7.5 million.

Economic development

and housing loan

portfolio servicing

Reduce costs and improve

services.

Outsourcing • Approximately $3 million estimated annual cost savings.

(continued)

Page 29 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Government Key initial action

Primary reasons for governmentwide

privatization efforts

Virginia Key legislators and governor created a competition

council in 1995.

Improve service and productivity of

government services.

Reduce cost of operations.

Indianapolis Mayor created a private-sector advisory group in 1992. Reduce size and scope of government.

Increase the quality and decrease the cost

of services.

Page 30 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Overview of governments’ select projects

Project Primary reason

Type of

privatizationa Reported resultsb

Delinquent tax

collection

Increase collections. Outsourcing • Estimated $6.8 million in collections in first year.

• Improved collection of previously uncollectable

 accounts.

Education loan

authority

Not considered to be a

government function.

Asset sale • State gained $62 million from sale of loan portfolio and

 building facilities that housed loan authority staff

 operations.

Child support

enforcement

Need to respond to

increased caseload and

take advantage of private

sector technology.

Outsourcing • Administrative cost of private office to collect $1 dollar

 support was 60 percent lower than public office

 during an 18-month period.

• Improved customer service satisfaction.

• Increased number of clients served.

Wastewater

treatment

Cost savings. Outsourcing • Estimated $65 million cost savings between 1994 and

 1998.

• Estimated cost savings represent a 42 percent savings

 over government provision of service.

• Increased capacity to treat effluent with fewer staff.

• Improved effluent quality.

• Better maintenance program resulted in improved

 equipment reliability.

• Combined sewer overflows reduced by 50 percent.

Airport management Promote economic

development.

Outsourcing • Estimated $105 million in cost savings or new revenues

 between 1995 and 2004.

• Estimated cost savings represent a 28-percent savings

 over government provision of service.

• 16.5 percent reduction in the cost per enplaned

 passenger from 1994 to 1995.

• 22 percent reduction in airline landing fees from 1994 to

 1995.

• Increased retail selection and quality for passengers.

Street maintenance Cost savings. Outsourcing/

managed

competition

• Estimated $700,000 in cost savings between 1992 and

 1996.

• Estimated cost savings represented a 30-percent

 savings over previous costs.

• Increased chuckhole crew daily productivity by 68

 percent.

• A 200-percent annual average increase in lane miles

 repaired (cracks sealed) between 1993 and 1996

 compared to 1993 baseline.

Audio-visual/

microfilm services

Cost savings. Outsourcing • Estimated $1.5 million in cost savings between 1992

 and 1995.

• Estimated cost savings represented a 54-percent

 savings over government provision of service.

• Eliminated prior 3-year backlog of service requests.

• Consistent achievement of turnaround requirements.

• Improved service to citizens using microfilm archives.

(continued)

Page 31 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Government Key initial action

Primary reasons for governmentwide

privatization efforts

Indianapolis (continued)

Page 32 GAO/GGD-97-48 Privatization Lessons Learned
Appendix III 

Overview of Recent Privatization Efforts in

the Six Governments

Overview of governments’ select projects

Project Primary reason

Type of

privatizationa Reported resultsb

Maintenance of city

vehicles

Cost savings. Managed

competition

• Estimated $4.2 million in cost savings between 1995

 and 1997.

• Estimated cost savings represent a 21-percent savings

 over government provision of service.

• Fewer labor grievances in first year of contract

 compared to prior 1-year period.

• Cost of workers compensation claims decreased by

 two-thirds since 1994.

Note: The six governments selected the projects to illustrate the range of activities that they have

undertaken in their recent privatization efforts.

aSee the end of this report for our glossary of privatization terms.

bAll results are as reported by the governments. We did not verify these results.

Sources: Georgia, Massachusetts, Michigan, New York, Virginia, and city of Indianapolis

government officials.

Page 33 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Most of the state and local government officials and experts we surveyed

said that having a framework or process was key to implementing

privatization because it provided a consistent approach for analyzing

government activities. All six governments used some form of analytical

framework to guide their decisionmaking. Some said that the repeated use

of such a framework shortened the learning time in analyzing government

functions.

These analytical frameworks typically included a step-by-step

decisionmaking process. Many of the frameworks established by the six

governments shared common elements, such as providing criteria for

selecting activities to privatize, an inventory of privatization candidates,

cost comparison and evaluation methods, and procedures for monitoring

the performance of privatized activities. Indianapolis, Michigan, and

Virginia had the most formalized frameworks and they are described

below.

The Indianapolis Costing

and Competitiveness

Model

After introducing competition into government in 1992, Indianapolis

included city employees through their union in the process for competitive

bidding for contracts to deliver city services. Once a number of activities

had been identified as candidates for competition, city officials developed

a three-phase approach to implementing a managed competition process.

The three phases were (1) determining the costs of government services

using activity-based costing, (2) openly and competitively bidding for

functions or services and contracting with either a city agency or

private-sector firm to provide those functions or services, and

(3) evaluating the level of performance of functions and services delivered

using a system of citizen and customer satisfaction surveys and measures

of cost and performance. The costing and competitiveness model is shown

in figure IV.1 and worked as follows.

First, city officials, after a discussion with the affected unions, decided

whether or not to open competitive bidding for an activity. If the decision

was to compete, the city then issued a request for proposals. City officials

provided a bid package to the union at the same time as other potential

bidders.

Second, to ensure that city employees were equipped to participate in the

process, the city provided managers and union members with the

analytical training they needed to spot inefficiencies, and with the

Page 34 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

knowledge needed to analyze and reduce costs. The city also provided

consultants to help city employees prepare their proposals.

Third, a union-management bid team reviewed the bid document and

determined (1) the number of employees and hours needed to perform the

function as well as the amount of equipment and materials needed and

(2) the necessary financial and performance information, which was

provided by management. The team then worked to streamline the work

processes and rewrite the workplan. Often with the help of consultants

provided by the city, the team then prepared the bid package which was

submitted along with private bids.

Fourth, at a public forum, all public and private-sector bids were opened

together and the winning bid was announced.

Finally, if the public sector won a competition and the union-management

team performed the activity at the desired level of performance for less

than it bid, the team received a share of the savings at the end of the year.

The city, after it tracked performance over a period of years, could place a

moratorium on bidding for areas for which city employees had

demonstrated performance excellence and in which they consistently

outbid private competitors.

Page 35 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Figure IV.1: The Indianapolis

Approach: Costing and

Competitiveness in the Delivery of

Public Services

Gainsharing and bidding moratorium

City may place a moratorium on 

bidding in cases where city workforce 

demonstrates constant superiority.

City workforce earns share of cost 

savings if it performed function 

under bid price. 

Step 5

Bid opening

Bids opened and announced at a 

public forum.

Step 4

Step 1

City discusses work with affected union.

City issues request for proposals.

City provides bid package to union.

Decision to compete

Step 3 Bid preparation and submission

Union determines number of workers and 

hours and amount of equipment and 

material needed.

Management provides financial 

information.

Union and management streamline 

workplan and submit bid.

Step 2

City provides training to give 

managers and workers knowledge 

needed to cut costs.

Training

Source: City of Indianapolis.

Page 36 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Michigan’s PERM Process Michigan established its framework in 1992. The framework provided a set

of procedures for analyzing government activities to determine if they

should be privatized, eliminated, retained in current form, or modified

(PERM). To accomplish these objectives, the PERM process included the

steps described below. Michigan’s operating agencies, Privatization

Division, and private contractors have performed PERM studies of state

activities and functions. Figure IV.2 illustrates this process.

Initially, agency directors used the Public-Private Partnership

Commission’s list of suggested activities1

 to choose functions and services

to be analyzed. The analyses were to be done using a three-part analytical

model developed by the Privatization Division in Michigan’s Department of

Management and Budget (DMB). First, an historical analysis of the activity

was done to identify factors that caused the state government to become

involved in the activity and whether those factors have changed. This

analysis also tracked the state’s level of responsibility throughout its

involvement.

Second, the agency prepared a report which recommended whether the

function should be privatized, eliminated, retained in current form, or

modified. This included evaluating the potential effects on customers and

other state activities of changing a function or service. It also included a

quantitative assessment of activity operations, as well as results to be

achieved and in what time frames. Issues involved in resolving potential or

pending issues (legal, liability, confidentiality, etc.) were also assessed.

Third, the agency prepared an analysis of the function or service’s current

costs, as well as a basis for determining the cost of operations if they

would be changed. For example, if the initial decision were to privatize an

existing state activity, the third part of the analysis would include both the

cost of the current program as well as an estimate of what the privatized

activity would cost. The latter would include estimates of the costs

associated with the transition from government operation to privatized

status. Agency management then reviewed the PERM analysis and decided

what action was to be taken. This decision was forwarded to the DMB’s

Privatization Division for review. Each recommendation was either agreed

to or, if not, it was renegotiated or studied further.

Since 1995, the focus has shifted from agency-initiated PERM studies to

Privatization Division-initiated PERM studies, particularly on functions and

1

Final Report-PERM: Privatize, Eliminate, Retain or Modify, Michigan’s Public-Private Partnership

Commission, December 1992.

Page 37 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

services that cross agency lines. Thus, the process changed in that DMB’s

Privatization Division would conduct studies, using the three-part

analytical model described above, after obtaining approval from DMB and

the Governor’s office. Privatization Division staff would then submit their

PERM analysis to the affected agency for review and comment. After DMB

and the affected agency negotiated the recommendation made in DMB’s

PERM study, both parties agreed on a decision to implement.

Michigan has also contracted out to have PERM studies conducted. The

state’s Office of Information Technology maintains a list of preapproved

PERM contractors, which agencies can contract with to perform PERM

studies. These are usually done in consultation with the Privatization

Division staff and the affected department and address issues outlined in

the three-part analysis model outlined above.

According to Michigan officials, most decisions calling for privatization,

elimination, retention, or modification could be implemented by executive

branch administrative actions. When privatization was recommended,

Michigan’s Civil Service Department reviewed agency proposals to

contract for personal services.2

 A proposed privatization also could be

subject to legislative approval if authorizing legislation needs to be

created, changed, or repealed.

2

As defined by Michigan’s Civil Service Commission Rules, personal services are services that the state

contracts for with persons who are not classified as employees of the state.

Page 38 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Figure IV.2: Michigan’s PERM Process

for Analyzing Functions and Services

Identify potential activities

to be analyzed.

Perform PERM analysis.

Decide if privatization, 

elimination, retention, or 

modification is appropriate.

Department of

Management and Budget

(DMB) and affected agency 

discuss and review PERM 

analysis.

Do DMB and 

affected agency 

concur?

Yes

No

Implement based upon

disposition decision.

Monitor and evaluate

privatization effort.

a

Page 39 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

aSubmit decision information to appropriate entities as required (e.g., Attorney General, Civil

Service, Contract Management, Facilities, Purchasing).

Source: Michigan’s Department of Management and Budget, Privatization Division.

Virginia Commonwealth

Competition Council

Process

Virginia’s framework, known as the Commonwealth Competition Council

(CCC) Process, was used to implement governmentwide privatization

efforts for the first time in 1996 (see figure IV.3). State officials told us that

most of the previous privatization efforts used a similar approach. This

process is dynamic as state government organizations may be at different

steps depending on their respective agency performance requirements.

In step 1, the Council held hearings to solicit input from citizens, business

interests, and government employees. Using this input and information

from functional departmental reviews, the CCC developed an inventory of

functions or services that could be opened to competition with the private

sector. The inventory for future years is published in the Council’s annual

report.

In step 2, agencies conducted a public-private performance analysis of

selected activities to determine whether they should be opened to

competition with the private sector. The performance analysis consisted of

five parts. The first part evaluated an activity’s potential for competition,

assessing such aspects as the private sector’s capacity and the state’s

ability to measure performance for evaluation purposes. The second part

assessed the full cost of operating the current activity as well as the

estimated cost of the contract for the function or activity considered for

privatization. The third part focused on public policy issues related to

public safety and welfare. The fourth considered issues involved in

planning the competition, such as personnel and transition considerations,

as well as contract administration. The fifth component considered

implementation issues such as procurement requirements and quality

assurance evaluation procedures.

In step 3, the agency requested proposals from private-sector firms and, in

certain instances, state agencies. The Council staff oversaw the cost

comparison evaluation process. An interagency team did an independent

review of in-house costs to ensure the government costs were complete,

accurate, and reasonable. The team was selected by and reported to the

Council and included officials from the offices of the Attorney General,

Planning and Budget, Purchases and Supplies, State Internal Auditor, Joint

Legislative Audit and Review Commission, the Virginia Institute of

Page 40 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Government, Auditor of Public Accounts, and Council of Higher

Education.

In step 4, the agency received sealed proposals from the private firms, and

if a managed competition was used, from public employees, and

announced a tentative decision to continue in-house performance or to

award the contract to a particular bidder. Contracts were awarded for a

period not to exceed 5 years.

Step 5 required that the agency establish an ongoing quality assurance

program to ensure that quality and cost standards established in the

contract were met. The agency was required to conduct a

postperformance review at the end of the contract period.

Page 41 GAO/GGD-97-48 Privatization Lessons Learned
Appendix IV 

Analytical Frameworks Used by

Indianapolis, Michigan, and Virginia

Figure IV.3: Virginia’s Commonwealth

Competition Council Process Inventory of 

competition/

privatization 

opportunities.

Monitoring

Establish an ongoing quality 

assurance program to ensure 

required standards of quality 

and cost effectiveness. 

CCC must conduct a 

postperformance review at the 

end of the contract period.

Step 5

Input

Gather input from

Public hearings

Business interests

Government agencies.

Step 1

Selection

Further determine the feasibility

of the competition/privatization 

candidates by conducting a 

public vs. private performance 

analysis.

Step 2

Have independent reviewers 

conduct evaluations.

Competition

Under the VA Public 

Procurement Act, conduct cost 

comparisons through the 

issuance and evaluation of 

requests for proposals.

Step 3

Award contracts for no more 

than 5 years.

Award

Make decisions to continue 

in-house performance or award a 

contract to a private-sector 

bidder. (These decisions are 

tentative and are subject to 

review and appeal by all affected 

parties.)

Step 4

Source: Virginia’s Commonwealth Competition Council.

Page 42 GAO/GGD-97-48 Privatization Lessons Learned
Appendix V 

Major Contributors and Acknowledgments

Major Contributors

General Government

Division, Washington, D.C.

John K. Needham, Assistant Director, (202) 512-5274

Donald L. Bumgardner, Project Manager, (202) 512-7034

Debra L. McKinney, Senior Evaluator

Hugh J. Ripper, Jr., Senior Evaluator

Anthony J. Wysocki, Evaluator

Acknowledgments

Staff Acknowledgments Anthony Assia, General Government Division, provided assistance in

reviewing report drafts and in communicating this report’s message.

State and City Government

Acknowledgments

The following officials in the six governments provided us with assistance

to learn about their governments’ privatization efforts and provided

comments on this report:

Charles D. Baker, Secretary, Executive Office of Administration and

Finance, Commonwealth of Massachusetts.

Phil Bomerscheim, Director, Virginia Commonwealth Competition

Council, Commonwealth of Virginia.

John E. Buttarazzi, Senior Vice President, Privatization Group, Empire

State Development Corporation, New York State.

Chere Calloway, Director, Privatization Division, Department of

Management and Budget, State of Michigan.

Skip Stitt, Deputy Mayor, and David Lips, Special Assistant for Policy

Development, City of Indianapolis.

Joe D. Tanner, Executive Director, Commission on Privatization of

Government Services, State of Georgia.

Page 43 GAO/GGD-97-48 Privatization Lessons Learned
Glossary of Privatization-Related Terms

Asset Sale An asset sale is the transfer of ownership of government assets,

commercial type enterprises, or functions to the private sector. In general,

the government will have no role in the financial support, management, or

oversight of a sold asset. However, if the asset is sold to a company in an

industry with monopolistic characteristics, the government may regulate

certain aspects of the business, such as the regulation of utility rates.

Competition Competition occurs when two or more parties independently attempt to

secure the business of a customer by offering the most favorable terms.

Competition in relation to government activities is usually categorized in

three ways: (1) public versus private, in which public-sector organizations

compete with the private sector to conduct public-sector business;

(2) public versus public, in which public-sector organizations compete

among themselves to conduct public-sector business; and (3) private

versus private, in which private-sector organizations compete among

themselves to conduct public-sector business.

Contracting Out Contracting out is the hiring of private-sector firms or nonprofit

organizations to provide a good or service for the government. Under this

approach, the government remains the financier and has management and

policy control over the type and quality of services to be provided. Thus,

the government can replace contractors that do not perform well.

Divestiture Divestiture involves the sale of government-owned assets or

commercial-type functions or enterprises. After the divestiture, the

government generally has no role concerning financial support,

management, regulation, or oversight.

Employee Stock

Ownership Plans

Under an employee stock ownership plan (ESOP), employees take over or

participate in the management of the organization that employs them by

becoming shareholders of stock in that organization. In the public sector,

an ESOP can be used in privatizing a service or function. Recently, for

example, the Office of Personnel Management established an ESOP for its

employees who perform personnel background investigations.

Franchising of Internal

Services

Under the franchising of internal services, government agencies may

provide administrative services to other government agencies on a

Page 44 GAO/GGD-97-48 Privatization Lessons Learned
Glossary of Privatization-Related Terms

reimbursable basis. Franchising gives agencies the opportunity to obtain

administrative services from another governmental entity instead of

providing them for themselves.

Franchising-External

Service

In the franchise-external service technique, the government grants a

concession or privilege to a private-sector entity to conduct business in a

particular market or geographical area, such as concession stands, hotels,

and other services provided in certain national parks. The government

may regulate the service level or price, but users of the service pay the

provider directly.

Government Corporations Government corporations are separate legal entities that are created by

Congress, generally with the intent of conducting revenue-producing

commercial-type activities and that are generally free from certain

government restrictions related to employees and acquisitions.

Government-Sponsored

Enterprises

Government-sponsored enterprises (GSE) are privately owned, federally

chartered financial institutions with a nationwide scope and limited

lending powers that benefit from an implicit federal guarantee that

enhances a GSE’s ability to borrow money in the private sector. They are

not agencies of the United States but serve as a means of accomplishing a

public purpose defined by law.

Joint Ventures See public-private partnership.

Leasing Arrangements Leasing arrangements are a form of public-private partnership. Under a

long-term lease, the government may lease a facility or enterprise to a

private-sector entity for a specified period. Maintenance, operation, and

payment terms are spelled out in the lease agreement. Under a

sale-leaseback arrangement, the government sells an asset to a

private-sector entity and then leases it back. Under a sale-service contract

or lease-service contract, an asset sale or long-term lease is coupled with

an arrangement with the purchaser to furnish services for a specified

period. Leases in which the government leases a facility (e.g., a building

lease) are considered a form of contracting out, rather than a

public-private partnership.

Page 45 GAO/GGD-97-48 Privatization Lessons Learned
Glossary of Privatization-Related Terms

Managed Competition Under managed competition, a public-sector agency competes with

private-sector firms to provide public-sector functions or services under a

controlled or managed process. This process clearly defines the steps to

be taken by government employees in preparing their own approach to

performing an activity. The agency’s proposal, which includes a bid

proposal for cost-estimate, is useful to compete directly with

private-sector bids.

Outsourcing Under outsourcing, a government entity remains fully responsible for the

provision of affected services and maintains control over management

decisions while another entity operates the function or performs the

service. This approach includes contracting out, the granting of franchises

to private firms, and the use of volunteers to deliver public services.

Performance Based

Organizations

Under a performance based organization (PBO), policymaking is to be

separated from service operation functions by moving all policymaking

responsibilities to a Presidential appointee. The service operations are

moved to an organization to be headed by a chief executive officer (CEO),

hired on a competitive contract for a fixed term. The CEO’s contract

defines expected performance and in exchange for being held accountable

for achieving performance, the CEO is granted certain flexibilities for

human resource management, procurement, and other administrative

functions. As of March 1997, several PBOs had been proposed but no PBO

had been authorized in the federal government.

Privatization The term privatization has generally been defined as any process aimed at

shifting functions and responsibilities, in whole or in part, from the

government to the private sector.

Public-Private Partnership Under a public-private partnership, sometimes referred to as a joint

venture, a contractual arrangement is formed between public- and

private-sector partners, and can include a variety of activities involving the

private sector in the development, financing, ownership, and operation of

a public facility or service. It typically includes infrastructure projects

and/or facilities. In such a partnership, public and private resources are

pooled and their responsibilities divided so that each partner’s efforts

complement one another. Typically, each partner shares in income

resulting from the partnership in direct proportion to the partner’s

Page 46 GAO/GGD-97-48 Privatization Lessons Learned
Glossary of Privatization-Related Terms

investment. Such a venture, while a contractual arrangement, differs from

typical service contracting in that the private-sector partner usually makes

a substantial cash, at-risk, equity investment in the project, and the public

sector gains access to new revenue or service delivery capacity without

having to pay the private-sector partner.

Service Shedding Divestiture through service shedding occurs when the government

reduces the level of service provided or stops providing a service

altogether. Private-sector businesses or nonprofit organizations may step

in to provide the service if there is a market demand.

Subsidies The government can encourage private-sector involvement in

accomplishing public purposes through tax subsidies or direct subsidies,

such as the funding of low-income housing and research and development

tax credits.

User Fees User fees require those who use a government service to pay some or all of

the cost of the service rather than having the government pay for it

through revenues generated by taxes. Charging entry fees into public

parks is an example of a user fee.

Volunteer Activities An activity in which volunteers provide all or part of a service and are

organized and directed by a government entity can also be considered a

form of outsourcing. Volunteer activities are conducted either through a

formal agency volunteer program or through a private nonprofit service

organization.

Vouchers Vouchers are government financial subsidies given to individuals for

purchasing specific goods or services from the private or public sector.

The government gives individuals redeemable certificates or vouchers to

purchase the service in the open market. Under this approach, the

government relies on the market competition for cost control and

individual citizens to seek out quality goods or services. The government’s

financial obligation to the recipient is limited by the amount of the

voucher. A form of vouchers are grants, which can be given to state and

local governments that may use the funds to buy services from the private

sector.

Page 47 GAO/GGD-97-48 Privatization Lessons Learned
GAO Privatization Products Related to State

and Local Governments

Child Support Enforcement: Early Results on Comparability of Privatized

and Public Offices (GAO/HEHS-97-4, Dec. 16, 1996).

Airport Privatization: Issues Related to the Sale or Lease of U.S.

Commercial Airports (GAO/RCED-97-3, Nov. 7, 1996).

Child Support Enforcement: States’ Experience With Private Agencies’

Collection of Support Payments (GAO/HEHS-97-11, Oct. 23, 1996).

Private and Public Prisons: Studies Comparing Operational Costs and/or

Quality of Service (GAO/GGD-96-158, Aug. 16, 1996).

Child Support Enforcement: States and Localities Move to Privatized

Services (GAO/HEHS-96-43FS, Nov. 20, 1995).

District of Columbia: City and State Privatization Initiatives and

Impediments (GAO/T-GGD-95-194, June 28, 1995).

District of Columbia: Actions Taken in Five Cities to Improve Their

Financial Health (GAO/T-GGD-95-110, Mar. 2, 1995).

(410032) Page 48 GAO/GGD-97-48 Privatization Lessons Learned
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