Investing in the mutualisation of public services
It is imperative that emerging mutuals are connected to sources of finance which can provide funding on terms which value the wider social importance of the model
Public sector mutuals offer particular benefits in the provision of public services. Driven by a desire to place social aims at their core, these organisations that have ‘spun out’ of the public sector are typically structured as social enterprises with a high degree of employee ownership and sometimes wider community membership. At their best, they are enhancing the relationship between citizens and the providers of public services beyond that which can be delivered either by the traditional ‘top-down’ model of state service provision or by private sector market provision.
The importance of mutuals in public service delivery was first recognised by progressives in the UK; at the Cabinet Office Ed Miliband shaped the previous Labour government’s strategy of placing citizen empowerment and greater autonomy for public sector professionals at the heart of improving public services.1 However, whilst political support for mutuals has grown, mutuals face a critical shortage of investment. Without a concerted effort by the social investment community, proactive steps taken by mutuals themselves, support from policymakers and the assistance of the wider cooperative movement, many of these new organisations could fail before they have a chance to succeed.
An opportune moment
The last UK Labour Government commenced a process of exploring mutualisation within a range of public services, from cooperative schools to groups of health workers forming employee owned social enterprises. The UK Coalition Government continues to support employee ownership as a means of improving public sector productivity, extending opportunities to staff under the “Right to Provide” across a range of UK public services, particularly in health and social care, where over fifty mutuals have been created since 2007. Seventeen of these are whole provider arms of community health services, with a combined turnover estimated at over £733m – organisations that, if well capitalised, have a real opportunity for innovation at scale.2
As a not-for-profit organisation that seeks to support social organisations in accessing capital, Social Finance believes that mutuals have huge potential to create both social value and improved productivity in public services.
In our view, the next five years will be critical in successfully establishing mutuals as a lasting feature of the public service landscape; history teaches us that once new models of provision are established they tend to endure.3 For instance, following the introduction of competition in 1992, around 15% of the UK prison population are now held in private prisons.4 Commissioning expertise, process and contracting structures grow up around established forms. The ‘mutualisation’ of prisons, for example, is now difficult to imagine given the market structures that have developed.
Capital in some form or other will always be needed
Yet even when mutuals are well positioned to improve services, they face a particular challenge. The best mutuals have taken with them significant assets in the form of a strong commitment to public service and to placing their relationship with citizens at the core of their enterprise. But many have come into being with relatively low levels of financial assets; many operate with low levels of reserves - some have only a few days’ cover – and have spun out without ownership of the land and buildings from which they operate. Analysis of first available community health provider accounts shows that over £80m of turnover was generated with around £800k of tangible assets.
Under-capitalisation can be a problem for all service organisations, but for mutuals the problem is even more acute. Where they have spun out of the public sector with a core service contract (typically lasting for between three and five years), margins are low and most are expected to deliver efficiency gains on these contracts – improvements which will require incremental investment in service delivery. Analysis of the same financial accounts reveals operating margins of 1.1% or lower. Competition in the new markets for public services will be against well-capitalised private providers. For these large organisations a strategy of building market share through loss-making contracts has been, and will prove, an attractive strategy.
Our engagement with mutuals and investors has found that traditional sources of corporate finance are ill-suited to this task. Some barriers would be associated with the development of any new model and should fall away as the market matures; new organisational models can be poorly understood, thus incurring transaction costs for investors disproportionate to the size or risk of the investment. However there are also structural barriers; traditional investors can find it difficult to fund organisations with community asset locks or with restrictions on the transfer of ownership rights or the payment of dividends. In seeking only a financial return, traditional investors treat as a downside – or at best an externality – the very factors which make the mutual model so attractive.
Meeting the demand
Given these challenges, it is imperative that emerging mutuals are connected to sources of finance which can provide funding on terms which value the wider social importance of the model.
How could this be achieved? Encouragingly, there are a growing number of institutions and individuals interested in social investment – capital provided on the basis of generating a social, as well as a financial return – which should be bolstered by the recent launch in the UK of Big Society Capital, the Government’s flagship social investment fund. This is mirrored by the growth of social investment-specific products, such as community shares and Social Impact Bonds. But the market is still nascent – only around £200m across all of the UK economy5 – and the need to support mutuals will be acute. Investors and arrangers of finance must do more to recognise the great potential of mutuals to deliver social impact, and identify the social investment opportunities that they offer.
Public sector mutuals too have a role to play in making this connection. Mutuals need to retain a focus on their strategic objectives and funding needs – not only for expansion, but for investment in service provision and retention of core contracts. They also need to understand the market for social investment and ensure that where possible, their legal and governance structures are conducive to securing investment. Where business plans may call for risk capital to support expansion, it may more easily be attracted if mutuals are constituted, for example, as companies limited by shares, allowing a small proportion of the shares to be sold to social investors or ‘financial members’. Social enterprises with financial expertise exist to provide support in these tasks, but mutuals must engage with them earlier rather than later. An initial wave of investment propositions is required to create market momentum.
Policymakers can make a difference too. They will need to set the stage for this market and its focus on mutuals. Recent developments have been positive, with the creation of Big Society Capital and consultation on the European Social Entrepreneurship Fund designation, and it will be important that support for public service mutuals is enshrined in the mission of such funds.
But as a movement, mutuals and co-operatives should also see this as a moment to draw on their own strengths. Employee-owned organisations are a powerful force within the UK economy, with a value estimated at £25bn ; they have not only resources to provide investment but also significant expertise in financing, sustaining and growing such enterprises. Either role represents a compelling opportunity to help grow the traditions of employee-ownership and mutualism in public services – the values which they themselves have championed. The Co-operative Group, the UK’s largest mutual organisation, offers an example of how this can be achieved. It funds the Co-operative Enterprise Hub, which delivers free advice and guidance to support the creation and growth of further member-owned enterprises, and the development of sector-specific financing models, such as community share issues. Co-operative and mutual finance organisations are starting to explore social investment too.
The initial contracts of many of the first public sector mutuals are soon due for renewal and unless alternative forms of finance develop quickly, a lack of access to capital will inhibit the ability of mutuals to invest in their service provision, to innovate, to expand or even to renew their core contracts. In explicitly valuing the wider benefits of the mutual model, social investment could meet this need. But as this market develops the focus of market participants on mutuals, the support of policymakers and the assistance of the wider cooperative sector will all be required. If the public sector mutual cannot endure and the public service ethos is lost, it will be difficult to recover.
Richard Todd is an associate at Social Finance; Ben Williams is an analyst
1 Excellence and Fairness: Achieving World Class Public Services – Cabinet Office 2008
2 NCVO: http://data.ncvo-vol.org.uk/almanac/civil-society/will-public-service-mutuals-reshape-civil-society/
3 Guardian: http://www.guardian.co.uk/uk/feedarticle/9858720
4 PCS: http://www.pcs.org.uk/en/prison_service_group/operation--penal-policy/prison-market-testing.cfm
5 Growing the Social Investment Market: A vision and strategy – Cabinet Office February 2011