Leisure in a post-pandemic world
As the dust settles following a tumultuous couple of years in the local authority leisure sector, we are encouraged to see outsourcing opportunities still receiving competitive interest.
Sport England recently released a new procurement toolkit and whilst some user friendly amends were made, the model remains largely unchanged. In this piece, we look at what the new template has changed and what it is missing. We also outline some different approaches that we are seeing in the market and the potential drivers for them.
The pandemic was a stark reminder of the common misconception that outsourcing means transferring all risk. Supply chain shocks with regards to the war in Ukraine (including Russian sanctions) and energy price hikes mean that contractors are considering relief claims as the unavailability of certain goods and higher utility costs are frustrating normal performance. In order to avoid expensive risk pricing, the usual outsourcing model (captured in Sport England's template suite of contracts) purposefully reserves certain risk items for the Authority. It is important from the outset when procuring these sorts of arrangements that the Authority appreciates this risk balance in order to contract manage effectively.
2021 Sport England toolkit
In 2021 Sport England released a new procurement toolkit for local authorities outsourcing the management of their leisure provision (with some helpful documents for other leisure delivery models too). The updated version has made some helpful, practical changes but also missed the opportunity to bring some outdated provisions up to date and introduced concepts which have received mixed responses.
The new template very explicitly says it hasn't been updated to take account of Covid-19 which feels to us a missed opportunity (though please note change in law amendments mentioned below in this section). Authorities are seeking to draw a line under "change in law" claims for the pandemic given, at the time of writing, there are no further Covid-19 restrictions. Some standard wording would be helpful as we see most procurements are now negotiating Covid-19 drafting with multiple bidders. It is also confusing why some key statutory provisions are not updated, including data protection legislation and many references still refer to EU bodies having jurisdiction over the UK.
We like the new inclusion of a risk allocation matrix which sets out some of the key risks in a table, allocates the risk between the authority, contractor or shared and gives some explanation. We think authorities will find this especially useful for their understanding. The risk balance has come into sharp focus given the crystalising of the Authority's risk relating to Covid-19. The matrix should be considered and amended if appropriate and made available with the procurement documents from the outset of the process.
Some of the new 2021 provisions haven't been received as well, including the changing of the "surplus share" provisions to "income share". In summary, the previous 2016 version provided that the authority and contractor shared profit in excess of the projected levels in specified proportions, whereas the new 2021 version includes that the authority has a share in the revenue in excess of the projected levels in a specified proportion. Whilst Authorities may rub their hands at getting a slice of a potentially larger pie, providers have commented that this creates an incentive for cost-cutting (to maximise profit on the same level of revenue) rather than maximising revenue (which equates to more leisure participation by the public). More revenue usually comes with an investment cost which can't be taken into account in this simplified calculation.
There are a number of other changes which don't have a material change on risk profile, which begs the question why they have been changed at all. But there are some changes that are significant for example the change in law provisions. The changes remove the ability for the contractor to recover revenue losses as a result of a specific change in law (eg. covid regulations).
It is therefore reassuring to know that Sport England are engaged in a further sector consultation exercise (to which we have been invited to contribute) and appear committed to updating the template Leisure Operating Contract further.
The Covid-19 pandemic was a stress test for the risk allocation particularly on "change in law" provisions which, due to state mandated lockdowns shutting all leisure centres, left the authority picking up the bill. In practice from our experience many Covid relief arrangements were negotiated and settled on a collaborative approach more favourable to authorities than the standard position, with contractors agreeing to work with the authority on services to mitigate losses and not to take a profit - later allowing the facilities to be used for vaccination centres in many authority areas. These examples show that the sector is collaborative and able to work through crises with commitment to the longevity of the relationships that weren't set out on papers. This begs the question whether some of the strict risk allocation within the contract doesn't actually hold water under the weight of a real crisis. Should the drafting be amended to reflect that reality? Or would that move the risk balance to an extent which providers won't accept? The leisure market appears to remain robust, there hasn't been a Carillion moment despite the hit in revenues, so perhaps there is scope to move away from some of the strict risk allocation in favour of a more collaborative or partnering approach.
Whilst the pandemic stress-tested the contracts, on the ground authorities and contractors went through a stress testing of their own. Many contractors led with an offering of taking no profit during lockdowns, this fired a starting gun for good will in discussions, but finance officers and members were still baulking at the potential sums that the authority would be on the hook for. The negotiation of financial settlements is likely to strain the best of relationships, especially for new or struggling outsourced arrangements where everyone was soon round a table with familiar faces discussing losses unimaginable during the tender exercise. If the relevant teams weren't well acquainted before Covid, they certainly will be now. From our experience that period has strengthened relationships and also potentially created helpful protocols which would suggest that more of a partnering approach to managing key risks is appropriate and ultimately what happens in practice anyway. The concept of working in partnership, incentivising joint decision making and aligning the parties' interests could be something to look towards in the future for different outsourcing models.
As if Covid wasn't enough of a shock to supply chains, the war in Ukraine and spiralling energy costs are feeding into the sector. We have seen that in some cases contractors are afforded relief under their contracts either by negotiated utility tariff risk share or even force majeure. The standard position under the new 2021 Sport England template contract is that utilities tariff risk sits wholly with the operator. We have however seen in many cases this be negotiated away with contractors under the previous 2016 edition. Supply chains which are reliant on Ukraine or Russian imports (for example some swimming pool chemicals are primarily manufactured in war-affected areas) may result in contractors being eligible for unavailability relief if they cannot deliver wet provision due to lack of sufficient materials to make it safe. Further risk share issues which see authorities potentially losing revenue or even having to fork out in some cases will be another testing strain on outsourced relationships.
The state of the market
Whether Covid will have a long term impact on leisure provision is yet to be seen, but some anecdotal evidence suggests that the outsourcing model is not dead nor completely faltering. Procurements are still going ahead, and there is still competitive bidder interest. All the big players in the industry survived the pandemic and are still seeking opportunities.
The same factors will play into whether the outsourced model is right for an authority. Often this is dictated by where the authority is coming from, a tumultuous couple of years of negotiations with an outsourced provider struggling to meet performance targets? Or an underperforming in-house asset base which is not delivering a good ROI? Wherever the authority is coming from it is important to understand the asset base, whether the facilities are underutilised/underperforming, what is the likely return on investment in equipment, capital works or new programme of activity? The answers to these questions may well be shifting as services seek to return to normal business.
On the other side of the fence, contractors are probably hesitant to bid for more risky opportunities, e.g. older facilities requiring investment and more proactive management, with potentially sluggish performance post-pandemic.
The cost of the pandemic will have shaken the nerves of some within authorities who may now prefer to manage all operations and risks in-house or at least in a controlled entity. We are indeed seeing a growing number of wholly owned leisure trading companies currently being established. But in-sourcing services isn't a simple feat nor is a panacea, so the decision shouldn't be taken lightly. A hybrid approach to in-house delivery through a wholly owned company, can provide a degree of commerciality with an "in group" circle of trust that some outsourced relationships aren't able to establish.
Our team have worked with a number of authorities through options appraisals as part of planned and strategic reviews or on a more informal discreet basis to help authorities understand their options. Our conclusions are that there is no one size fits all, outsourcing does not outsource all risk, and in-sourcing takes diligent planning and risk management.