NZTA’s spending on consultants has been in the news recently; millions of dollars have apparently been spent on investigation and design for the RONs. Some people, such as Gordon Campbell, have suggested the money is being spent on “consulting oligarchs.”
As a consultant myself I find such discussions very interesting. Afterall, someone has to design these things and we sure as hell want to get it right: Auckland is littered with examples of poorly designed transport infrastructure. For this reason I suspect society is prepared to pay quite a lot for well-designed transport infrastructure. On the other hand, there are valid questions to be answered about whether our spending on consultants is as effective as it could be. I think not, even if I know that talk of “consulting oligarchs” is a tad OTT.
In this post I will attempt to provide some brief personal insights into how transport consultants actually operate and some personal reflections on whether it is effective and how it might be improved. The best starting place is to think about the ways that consultants get work. That is, is the money handed to them on a plate? Or do they have to kow-tow to the Government Gods by upping quality and trimming their prices? The truth, as usual, is somewhere in between. By way of background, consultants typically get work through one of three unique channels:
- Direct referrals – Where a particular consultant is shoulder-tapped by the client to deliver a particular project. These are usually awarded where a particular consultancy has done the hard yards in drumming up interest in a project, or is the obvious market leader in a particular area.
- Invited tender – Where a select group of consultants are invited to submit proposals for a particular project. These occur where the government client has a good idea of what they want and also which consultancies have the skills to do the job, but they want to provide some scope for competitive tension and innovation while maintaining transparency.
- Competitive tender – Where the government client knows what it wants but wants to see what the market can offer either in terms of quality of price or both. This is really the neo-liberal nirvana …
Now most people would intuitively think that #3 (competitive tenders) are the way to go: After all surely this option provides the best way for government clients to receive the best combination of quality and price?
The problem is (and it’s a big problem) is that #3 can be extremely inefficient, especially for small projects. The reason being that competitive tenders are very resource intensive. In preparing a response to your average $200k transport project a company might incur $20k in costs. And in the long run these tendering costs will ultimately be borne by the government client, because consultants will need to make back the costs of tendering from the jobs they win. If they do not recoup the tendering costs overall then they will eventually go out of business, which reduces competition.
But that is not all: Having received the tenders the government agency must then spend considerable time carefully evaluating each one. This is not a quick and easy process: Think of the costs involved in having people to read 10 proposals of 100 pages each, before then getting together to evaluate which is best.
All in all I think that competitive tendering ends up costing our government clients considerable amounts of money, both directly and indirectly. Intriguingly in some instances, especially for small projects, the costs of tendering is likely to exceed the social value of the project, i.e. society experiences a net economic loss from a competitive tendering process.
Fancy that I hear you say?!? Competition that yields higher, rather than lower costs. From an economic perspective competitive tendering can be characterised as an arms race with imperfect competition. The arms race occurs because tendering costs are a “race to the bottom” – consultancies throw everything they have into the tender because the pay-offs are highly asymmetric; you either win and take all the booty or lose and get nothing. Just like in nuclear war, although in this case “winning” means avoiding annihilation, which is the fate of the loser.
But that is not all, competitive tenders are also characterised by imperfect competition because:
- There are large barriers to entry into the transport consultancy market – such as specialized/local knowledge, which prevent new consultancies from simply starting up in response to high prices; and
- There are economies of scale, i.e. the optimal firm size is larger than the level that delivers effective competition. This is largely due to the presence of fixed costs and cyclical demands creating a need for diversification.
The combined effect of this arms race and imperfect competition is that transport consultants know that ultimately (and at some point) they can pass on the costs of competitive tenders to their government clients – and that their competitors are doing the same. And this ultimately will mean that the costs of consultants will be higher than it should be in a case of marginal cost pricing.
But enough with the theory, what about in practise? Well, I think that up until recently (i.e. early 2000s) NZ’s transport consultancy market was dominated by big players, such as Opus, Beca, Aecom, SKM, GHD, and Connell-Wagner. These consultancies knew that they had market power and boy did they exercise it: Consultant rates boomed and high profits resulted.
Recently, however, I suspect that a combination of factors have driven profit levels down. The first is simply that the rents extracted by the consultancies stimulated increased competition. This competition was aided and abetted by improvements in telecommunications and lower cost airfares, which made it possible for smaller, niche companies to overcome their lack of scale and local presence by pooling resources across countries and thereby servicing the NZ market. This is the story of my company.
The second important recent factor is that government clients have started to manage the tendering process better and in the process help to make the consulting market more efficient. This has been achieved, for example, by filtering potential consultancies and managing proposal costs. This ultimately means the the average costs incurred in winning work across the industry has probably come down, benefiting our government clients.
Let’s briefly consider how government clients might extract better value from transport consultants; some of my ideas include:
- Proactive pre-filtering: Combine the best elements of competitive tendering and invited tender by going to market early with a very specific request for expressions of interest. Invite respondents to come and present workshops to your staff. The government can then select the top 3-5 consultancies to submit more detailed written proposals. It’s better to let consultants know early that they do not make the grade, rather than have them incur considerable costs for no cigar.
- Reduce tendering costs: Don’t think that you can externalise costs onto the consultant. In the long run costs will be reflected back to our clients, just in an indirect way through higher average hourly rates. For this reason it is in your (collective) interest to reduce the costs of tendering through, for example, being clear in your requirements. I would strongly suggest you specify a page limit (say 20 pages) and also specify your budget (especially for smaller strategic projects) so that the consultancies’ effort is invested in quality rather than a guessing game about the budget and other people’s prices.
- Reduce barriers to entry: In my experience, NZ government agencies have an almost pathological attachment to receiving hard copies of tenders. This creates a huge advantage for local firms who effectively get an extra 1-2 days to develop their proposal, compared to consultancies located in other cities who must instead courier their proposal in. Many Australian tenders now accept electronic submissions, which is a really good way to increase competition from consultancies located elsewhere (and also reduces costs).
- Reduce risk: I think one of the major issues with competitive tendering is the “winner-takes-all” mentality. While in some places this makes sense (e.g. where considerable intellectual IP is being involved) in others it does not; for example reports that will eventually be made publicly available. For these types of projects government clients could possibly consider a process whereby they force different consultants (say the top two) to work together on a project. Or alternatively, the top consultant could win the job while the second best consultant is commissioned to perform a peer-review of their work. In this way the risks of not winning are reduced and the arms race mentality of competitive tendering may be subverted.
I should also say that I tend to agree with Gordon Campell when he suggests that government clients would do well to internalise more of the simple, repetitive functions that they have outsourced to consultants during the last few years. The way to do this is simple: Make sure that you are not using consultants for cookie-cutter projects; instead develop your internal capacity. As Tim Hazledine has noted in his critiques of NZ’s economic reforms, transactions costs are not insignificant and sometimes best overcome by simply developing the capacity of the public sector (again, a good topic to raise with your neo-liberal minded friends).
Finally, what does this mean for salaries? Are transport consultants over-paid? Well, in my experience they are not relative to what they could earn in other professions. A new graduate might earn between $50-$60k depending on their academic background and level of knowledge, whereas someone like myself with 7 years experience can expect to earn between $80-$100k. Salaries in the sector go up to about $200k depending on the level of management responsibility you take on. So in my experience transport consultants are fairly well paid, but not excessively so.
And this indirectly answers the question posed in the title of this post: Do consultants fees reflect private super-profits or public sector waste? My suggestion is, in the past, super-profits were earned, but that the market is increasingly competitive and further gains are most likely to come from improving public sector procurement practises (which currently rather ironically tend to externalise costs onto the private sector). But I’m only a relatively young buck so I’d be interested to know what some of the other wiser heads that read this blog think about the effectiveness of consultants and the wider tendering process?