Appendix 1 EAST HAMPSHIRE DISTRICT COUNCIL Portfolio ... EHDC … · State Aid Manual July 2015 Figure 1. Seizing opportunities out of complexity ... Information is material if its

Appendix 1

8th DRAFTCopyright © 2017 by EHDC. All Rights Reserved

NON EXEMPT

EAST HAMPSHIRE DISTRICT COUNCIL

Portfolio Holder: Ferris Cowper

PRICING STRATEGY

Report by: Tom Horwood, Executive Director Chris Bradley, Head of Commercial Development

Copyright © 2017 by East Hampshire District Council (EHDC)

All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by East Hampshire District Council’s (EHDC) constitution and copyright law. For permission requests, write to the publisher, addressed “Attention: Commercial Directorate,” at the address below:

EHDCCouncil OfficesPenns PlacePetersfieldHampshire GU13 4EXUnited Kingdom

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1.0 Purpose of Report

1.1 This report seeks approval for the implementation of the Pricing Strategy as detailed below; a critical component in the creation of a financially sustainable, commercially focused council.

2.0 Background

2.1 Financial stability is a key priority for East Hampshire District Council. Effective pricing through charging (fees & charges) and trading (commercial activities) is a critical success factor in assuring the council achieves financial stability.

2.2 Pricing in Local Government is far more challenging than in the commercial world due to the complex legislative, political and cultural environment. Figure 1 highlights some of the legislation councils must comply with in setting prices and undertaking commercial activities.

2.3 A highly competitive and dynamic market, the public sector mixed economy adds to the complexity. With the market consisting of major commercial players such as Capita and Serco, large public sector companies like Norse Group and CORMAC, and a wide range of emerging local authority trading entities such as NABCEL (Nuneaton), Streetwise (Rushcliffe) and our own EH Commercial Services. On top of this are a growing number of Joint Venture (JVs) and Special Purpose Vehicles such Babcock4S (Surrey & Babcock), Orbis (Surrey & East Sussex Councils) and Five Councils (Capita & 6 x authorities).

2.4 Yet this complex environment also presents great opportunities, for example the “Teckal” exception to Public Contract Regulations 2015 helps reduce procurement costs.

2.5 Success for East Hampshire will require an agile and responsive approach to pricing. With the ability to rapidly adapt to dynamic market and social needs, while retaining the appropriate political and legal controls on policy, sensitive areas and the public purse.

2.6 This need for agility and responsiveness will require the council to, where appropriate, move the authority to set some prices, (within constraints) to the point of market information. Moving authority will also promote cultural change; encouraging and enabling colleagues to take ownership and responsibility for income generation. Active buy-in by colleagues is likely to increase revenue.

2.7 As a public body, the council must be able to balance the needs for revenue, against social value and place development. This will be achieved through the development and application of a Triple Bottom Line (TBL) of Profit, People and Place.

2.8 This Pricing Strategy aims to seize the opportunities in this complex environment, while complying with the legal constraints, providing the council with:

a simple, practical framework for pricing political agility for Cabinet flexibility in balancing the needs of profit, people and place

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competitive advantage to win and retain business a vehicle for cultural change

2.9 Structure of Paper

For ease of reference, the structure of this paper is as follows:

1.0 Purpose of this Report2.0 Background3.0 Principles4.0 Common Costing Model5.0 Risk and Contingency6.0 Pricing7.0 Trading - External Organisations8.0 The Cash Cycle9.0 Summary

Annexes:

Examples of Local Government Charging and Trading Powers

Local Authorities (Land) Act 1963 - development Civil Restaurants Act 1947 - restaurants, meals and refreshments at costLocal Authorities (Good and Services) Act 1970Local Government Act 1972

S.113 staff secondmentS.145 entertainmentsS.139 gifts, property and incidental works

Local Government (Miscellaneous Provisions) Act 1976 S.11 renewablesS.19 leisure & recreationS.32 works outside areaS.38 computers & equipment

Building Act 1984 S.97 works

Housing Act 1985Road Traffic Act 1988

S.24-26 privately let housingS.45 MoT testing

Town and Country Planning Act 1990Environmental Protection Act 1990

S.45 commercial or industrial waste (no charge for domestic)Local Government Act 2003

S.12 powers to investS.93 limitation to cost recoveryS.95 commercial purpose

Local Government (Best Value Authorities) (Power to Trade) (England) Order 2009The Localism Act 2011 - General Power of CompetenceThe Public Contracts Regulations 2015

S.12 contracts between entities within the public sectorState Aid Manual July 2015

Figure 1. Seizing opportunities out of complexity. Pricing in local government is more complex due to the legal environment but this creates opportunities as well as constraints.

Appendix 1


A. Common Costing ModelB. Pricing Strategy Pricing Processes Flow ChartC. Estimating a Price to WinD. Trading Costing & Pricing Strategy

3.0 Principles

The pricing strategy is guided by the following principles:

1. Commercial by default2. Agility and flexibility3. Risk verses reward4. Materiality5. Understand customer requirements: scope, quality, time & cost6. Balancing profit, people, place7. Accurately costed8. Incremental costing9. Competitiveness 10.Managed risk and contingency11.Cash flow is king12.Legally compliant 13.Auditable

3.1 Commercial by default – Adopting the spirit, principles, or procedure of commerce appropriately applied to local government

3.2 Agility and flexibility – The ability to rapidly change direction (agility) or adapt (flexibility) to the market and social environments

3.3 Risk versus reward – the direct relationship between possible risk and possible reward which holds for a particular situation

3.4 Materiality – Materiality is an accounting/auditing principle that relates to the significance of transactions, balances and errors contained in the costing exercise.. Information is material if its omission or misstatement could influence the economic decisions taken.

3.5 Understand customer requirements: scope, quality, time & cost – clarifying and balancing customer requirements, specified and implied, against defined scope, quality, time and cost. Managing customer expectations and risk for all parties to ensure customer satisfaction while delivering the expected ROI.

3.6 Balancing our needs; profit, people, place – each decision must balance the need to generate revenue, improve peoples’ lives and create a better quality of environment

3.7 Accurately costed – Without good cost information, a business operates in the dark. Businesses must carefully record all their costs correctly so that managers have the best information available to make decision

3.8 Incremental Costing – This principle may apply to business activity that is incidental to and not a material part of, the organisation. Ensuring pricing is as

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competitive as possible and without inappropriately subsidising activities. Care must be taken to ensure the long term expectations on price by customers are manged appropriately, particularly if a margin is not to be added.

3.8.1 The cost associated with any incremental business activity may reflect only the marginal costs of carrying out that business activity.

3.8.2 The marginal cost is limited to those costs that must be incurred exclusively for the new business activity. No overhead allocation is required for marginal costs, nor should the business activity bear any average costs.

3.8.3 A good test of the proposed marginal cost is if the business activity was stopped, would all of the identified marginal costs be fully saved? If not then they are excluded from the marginal cost calculation. If so, then they should be included.

3.8.4 Some examples follow:

a. In the case of energy consumption, a valid marginal cost is the volume of kwH directly consumed by the activity, multiplied the marginal Utility Company charging rate. Do not use the average rate per kwH that the organisation pays, (because it includes fixed fees).

b. In the case of management overhead, the following example is illustrative. An activity has a marginal cost of £10 in a department that costs overall £100. The manager of that department costs a further £50. It would be wrong to argue that £10/100 x 50 = £5 should be allocated to the activity because if the activity was stopped and the manager would still be retained then the council would continue to pay their cost of £50.

c. However, if the activity consumed a material amount of the manager’s time, say 5%, (2 hrs a week every week), then the marginal cost should bear £2.50 of that £50 cost. If the activity was stopped the manager would have 5% spare capacity and senior management would be required to reorganise tasks to resume that manager’s utilisation to 100% and locate savings elsewhere such as in overtime.

3.9 Competitiveness – the ability and performance to sell and supply goods and services in a given market, in relation to the ability and performance of other organisations in the same market

3.10 Managed risk and contingency – the ability to accurately identify, cost and mitigate material risk so that it does not adversely impact on the planned return on investment

3.11 Cash flow is king – primary consideration of how to manage the cash cycle, particularly the funding gap between cash out and cash in

3.12 Legally compliant –being seen to comply with the law while minimising the cost, financial and reputational, to the business

3.13 Auditable – the ability to evidence decision making and commercial activities, especially financial accounts and health and safety

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4.0 Common Costing Model

4.1 Accurate and comprehensive costing is critical to effective pricing. Following the principle of commercial by default, there is a need to apply a common language and outline structure to help staff to understand and quickly build effective cost models.

4.2 However, a council’s operating expenses or overhead differs form a commercial business, in that it undertakes additional activities, such as democratic services and statutory public consultation. If these additional operating expenses or overhead are included in the costing of a competitive commercial tender the council would be uncompetitive on price when compared to a commercial competitor.

4.3 In some circumstances, legislation restricts the council to cost recovery only. Particularly when working with other public authorities, as in S.93(3) Local Government Act 2003. While in these situations a margin may not be added, all reasonable costs and overheads may be included; thereby providing councils with some financial incentive and benefit for undertaking such activities.

4.4 A flexible approach to the costing of operating expenses or overhead is required to ensure the council is able to achieve a return on investment in both the ‘cost recovery only’ and ‘commercial competitive’ environments.

4.5 This can be achieved by separating operating expenses or overheads into two distinct groups; Council Overheads and Business Overheads.

In the ‘commercial competitive’ environment, the Council Overheads may be excluded and a margin may be added.

In the ‘cost recovery only’ environment the Council Overhead may be included but no margin added.

4.6 A visual representation of the common costing model, showing the separation of operating expenses, may be found at Annex A.

5.0 Risk and Contingency

5.1 All risk costs money. If not accurately accounted for, at best, poor risk management can leave the council in a position where it is subsidising customers i.e. other local authorities. At worst it can put the existence of a trading entity at risk or destroy reputations. If over accounted for, poor risk management can make an offer uncompetitive on price and lose work.

5.2 Significant over accounting of risk, and therefore over pricing, may creep into cost models if risk is either deliberately or unwittingly added to each cost line separately. An example would be an IT provider whose staff include additional equipment to a cost line…. just in case!

5.3 The challenge is therefore how to mitigate risk, through spend to save e.g. insurance and contingency (reserves), while remaining price competitive.

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5.4 A coherent, simple approach to identifying, grouping, costing and negotiating risk offers an opportunity to:

Build a trusted relationship with clients Create competitive advantage Improve a negotiation position Improve the quality of delivery Protected both parties Increase profits

5.5 For those risks with a high impact or high probability (red risks) special arrangements must be made to cover the whole risk. Such arrangements may include a combination of insurance, contractual clauses or budget contingency. However, treating all risk in this way is likely to be cost prohibitive.

5.6 Lower impact or lower probability risk (green risk) may be grouped with similar risks. Not all of the risks will occur, so an educated estimate may be made on the percentage of risk likely to occur within each group. This will allow a reduced level of insurance to be purchase and/or a reduced level of budget contingency to be set aside.

5.7 Contingency is not a ‘slush fund’ or ‘padding’ to cover for poor project management: it should be justifiable and reviewable. Contingency is there for specific risks and should only be released if a risk occurs. The Contract/Project Steering Board or its equivalent should authorise or delegate the release of contingency funds.

6.0 Pricing

6.1 The type pricing the council may apply is determined by the legislation outlines in Figure 1 above. These pricing types fall into three basic categories:

1. Charging (Statutory) A price is set nationally by a statutory body for specific services/products to residents, local businesses and other local authorities. Prices may be fixed, capped or benchmarked against the market rate.

Figure 2. Real World Costing. A Contract with all of these elements in the cost is funded to survive in the real world.

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2. Charging (Discretionary) Discretionary services/products to residents, local businesses and other local authorities may be priced on a cost recovery basis or benchmarked against the market rate.

3. Trading of services/products for profit to the public, commercial and voluntary sectors.

6.2 Processes. To support the 3 pricing types there are 3 processes for calculating price; market rate, cost recovery or fixed by law. A flow diagram illustrating the different processes may be found at Annex B.

6.3 Relationship. The relationship between the 3 x Pricing Types and 3 x Pricing Processes for pricing is illustrated in Figure 3. Examples of services within each category are provided in Figure 4.

6.4 Authority to Set Prices

6.4.1 Charging (Statutory). The authority for setting pricing policy for Charging (Statutory) services lay with the statutory body. This may be a fixed price or cost recovery or a capped limit.

6.4.2 Charging (Discretionary). The authority for setting prices for discretionary charging lay with Cabinet, subject to the advice of the Section 151 and

Trading Charging (Discretionary) Charging (Statutory)

Market Rate Market Rate Cost Recovery Cost Recovery or Capped Fixed

Consultancy Pest Control Car Parking Building Control Planning Fees

Pricing Process

Pricing Types Charging (Statutory)

Trading Charging (Discretionary)

Market Rate Cost Recovery or Capped Fixed

Figure 3. Clarity of Relationship. The pricing type is determined by the legislation, these are supported by 3 simple pricing processes.

Figure 4. Working Examples. These examples illustrate that different legally defined pricing types may use different pricing processes.

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Monitoring Officer. Legislation specifies if this must be cost recovery or profit based.

6.4.3 Trading. The authority for setting prices for trading for public to public contracts lay with Cabinet, subject to the advice of the Section 151 and Monitoring Officer. Legislation specifies if this must be cost recovery or profit based.

6.4.4 Local Authority Trading Companies. The authority for setting prices in Local Authority Trading Companies lay with the Board of Directors.

6.4.5 Delegation. the authority for setting discretionary charges and trading prices, should be delegated, in writing, to the point of market information. In the first instance this would be the Head of Service but this may be delegated down to Service Leads. Delegation may specify any specific freedom and/or any constraints.

6.5 In all cases pricing must be legally compliant and fully auditable.

6.6 All pricing must take into consideration risk and where appropriate include a risk model showing spend to save measures and contingency.

6.7 All contingency must have an allocated authority for its release.

6.8 All pricing for work over greater than one calendar month, or complex in nature, or high risk, must take into account cash flow and any funding gap.

7.0 Trading - External Organisations

7.1 Trading involves the sale of services/products for profit to all three sectors.

7.2 The vast majority of the council’s traded sales will be services. Services are more difficult to price than goods and carry inherent risk because they represent an intangible commodity with the following 5 key characteristics:

Intangible Inventory (perishability) Inseparability from the person delivering Inconsistency (variability) Involvement require the participation of the customer

7.3 Pricing to win the trading of services/products is therefore an art not a science. This requires judgement and consideration of the statutory, political and social market environments. As well as competitive considerations around the following factors:

Customer budget Customer expectations Low cost solution Best value solution

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7.4 A visual representation of factors that may be considered in the art of estimating a price to win may be found at Annex C.

7.5 The council is able to provide a wide range of services, from Litter Enforcement to Planning, to a wide spectrum of organisations from the public, commercial and third/voluntary sectors.

7.6 The degree of complexity of pricing and risk mitigation will depend upon the task. Tasks may include simple consultancy, to design with defined deliverables, to build or even operate.

7.7 As a local authority the purpose of a sale may be more sophisticated than simply profit. The sale may seek wider people or place benefits, for example supporting local voluntary services. The ‘Purpose’ may therefore include subsidise, direct cost recovery, business expenses cost recovery, full recovery or profit.

7.8 Annex D provides a simple framework guide for colleagues to understand the relationship between complexity of task and purpose of the sale. Each segment shows the key components from the Common Cost Model at Annex A that should be considered.

8.0 The Cash Cycle

8.1 Cash flow is the lifeblood of a business, without it you cannot survive. Even the most profitable firms can find themselves going out of business because their cash is tied up in unpaid invoices.

8.2 A key component in managing cash flow is pricing and the construct of payment terms. Particularly in the delivery of services which may take place over an extended period, from days to months.

8.3 Consideration of the cost of funds required to close a gap is required and should be included in any pricing calculations. The diagram in Figure 5 below highlights the funding gap challenge.

8.4 To reduce or even eliminate the funding gap, and therefore reduce costs and the price to the client, pricing strategies should consider payment terms both from clients and to suppliers. For work that takes place over an extended period consideration should be given to phasing payments in line with defined deliverables.

8.5 Those individuals authorising prices must satisfy themselves that any funding gaps are identified and either closed or the cost of capital included in the price.

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9.0 Summary

Financial stability is a key priority for East Hampshire District Council. Pricing in Local Government is far more challenging than in the commercial world due to the complex legislative, political and cultural environment. A highly a competitive and dynamic market, the public sector mixed economy adds to the complexity. Yet this complex environment also presents great opportunities. Success for East Hampshire will require an agile and responsive approach to pricing. This need for agility and responsiveness will require the council to, where appropriate, move the authority to set some prices, (within constraints) to the point of market information. As a public body, the council must be able to balance the needs for revenue, against social value and place development.

This Pricing Strategy aims to seize the opportunities in this complex environment, while complying with the legal constraints, providing the council with:

• a simple, practical framework for pricing• political agility for Cabinet• flexibility in balancing the needs of profit, people and place • competitive advantage to win and retain business• a vehicle for cultural change

Annexes:

A. Common Costing ModelB. Pricing Strategy Flow DiagramC. Estimating A Price To WinD. Trading Costing & Pricing Strategy

Agreed and signed off by:

Head of Finance: Andy Radford 27 September 2017Monitoring Officer: Nick Leach 27 September 2017Executive Director: Tom Horwood 7 September 2017

Figure 5. Manage the Funding Gap. Pricing strategies must Identify funding gaps and close them by moving stock faster, being paid quicker, delaying the payment of suppliers or charging for the cost of capital to cover the gap.

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Cllr Cowper, Portfolio Holder: 7 September 2017

Contact Officer: Chris BradleyJob Title: Head of Commercial DevelopmentTelephone: 07403 020 255E-Mail: [email protected]

Appendix 1


ANNEX A

COMMON COSTING MODEL

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PRICING STRATEGY FLOW DIAGRAM

Pricing Strategy (3 Yearly)

Budget Setting

TRADING

Staff Rate Card On-Costs

Business Overheads Charge

Council Overheads Charge

Budget Book Appendix

Costed

ManagementSign Off

Direct Costs(incl T&S)

Overheads(Fixed costs)

Strategic Fit, Purpose & Task

Margin

VAT

Estimate Price to Win

Price (Within Proposal)

Management Sign Off

Risk & Contingency

Contract Type (T&M, Cost +,

Firm/Fixed

Delegation of Authority

Published on website

Identify & Track

CHARGINGDISCRETIONARY

CHARGING STATUTORY

MARKET RATE PROCESS COST RECOVERY OR

CAPPED PROCESSFIXED PROCESS

Direct Costs(incl T&S)

Overheads(Fixed Costs)

Strategic Fit, Purpose & Task

Risk & Contingency

CabinetSign Off

Delegated?YES NO

Delegated?

CabinetSign Off

YES NO

CHARGING TYPES

Consultation

Consultation?

NO

YES

KEY

Process

Document

Decision

ANNEX B

Appendix 1


ANNEX CESTIMATING A PRICE TO WIN

Appendix 1


ANNEX DTRADING COSTING & PRICING STRATEGY

PURPOSE (Determined by type of customer, legal constraints and corporate strategy)Subsidise

(Charge to internal budget)

Direct Cost Recovery(i.e. incremental costing)

Business Overhead Recovery Full Overhead Recovery Profit

Design Consultancy

(No Deliverables)

Time & materials- Travel & Subsistence

Time & materials - Travel & Subsistence

Time & materials- Travel & Subsistence- Business Overheads

Time & materials- Travel & Subsistence- Business Overheads- Council Overheads

Time & materials- Travel & Subsistence- Business Overheads- Margin

Design Consultancy

(+ Deliverables or Outcomes)

Time & materials- Travel & Subsistence- Contingencyor

Fixed/Firm price

Time & materials- Travel & Subsistence- Contingencyor

Fixed/Firm price

Time & materials- Travel & Subsistence- Business Overheads- Contingencyor

Cost plusor

Fixed/Firm price

Time & materials- Travel & Subsistence- Business Overheads- Council Overheads- Contingencyor

Cost plusor

Fixed/Firm price

Time & materials- Travel & Subsistence- Business Overheads- Contingency- Marginor

Cost plusor

Fixed/Firm price

Build

Time & materials- Travel & Subsistence- Contingency or

Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price

TASK

Operate


Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price


Cost plusor

Fixed/Firm price

Documents

Appendix 1 EAST HAMPSHIRE DISTRICT COUNCIL Portfolio ... EHDC … · State Aid Manual July 2015 Figure 1. Seizing opportunities out of complexity ... Information is material if its