Before the ‘credit crunch’ hit, it was estimated that the amount spent on public sector outsourcing would grow to £65.2 billion by 2009, largely due to pressure on the public sector to control costs and improve service delivery. Following the crunch, some doubt has crept in as to whether this growth rate is possible, not because the public sector has lost its appetite, but because the credit squeeze may limit outsource providers’ ability to take on major new capital investment projects.
A huge change has undoubtedly occurred in the past six months. Straight debt facilities are not as readily available as they once were, making it more difficult for outsourcers to raise the necessary funds that in the past provided the up-front capital injection that many projects in the sector require.
This has to be a big worry for Healthcare Trusts who have become used to the many benefits of outsourcing. First and foremost of these is direct access to services and technology without the associated risk or capital expenditure exposure. This enables patients to get the healthcare they need, when they need it, allowing staff to concentrate on the job in hand; caring for patients.
Following the tightening of the credit markets and the resulting limited availability of cheap debt facilities, it can only be a matter of time before outsource providers are forced to rein in their offers.
On the face of it, this may sound bleak for the Healthcare sector, however, outsource providers needn’t become ailing patients themselves. Firstly, it is important to state that not all outsourcers will be affected, and certainly not in the same way. Catering and cleaning outsourcers, for example, may be relatively unaffected simply because they are less likely to have major capital investments to contend with. On the other hand, high tech medical equipment providers could find the current credit climate more of a challenge.
The real question will be: how will the outsourcers, and ultimately the Healthcare Trusts, cope? Some outsource specialists will be cash rich, and therefore in a good position to fund capital expenditure direct from their own balance sheet. Others will have contracts already in place, but without specific project related funding. In these circumstances, there is the potential to free up normal banking debt lines to be used for other capital expenditure or other operating expenditure. In order to do this the banks would have to assess and conclude that there is a proportion of a payment in a service contract that is isolated from the majority, if not all, of the service delivery related payments due from the Healthcare Trust.
Similarly saleable, structured or asset-based financing can be set up at the outset of the contract that allow for the long-term value of the end customer’s service payments to be taken into account as a financial asset, so that in times where funding liquidity is a more scarce resource, outsourcers can open up additional avenues of financing. In this circumstance it is clearly in the mutual interest of the Healthcare Trusts and the Service Providers to work together. In doing so they will be in a better position to arrange funding secured on the payments in the service contract, helping to widen the funding sources available to the Service Provider, which in turn allows them to continue offering a service based solution to large capital projects.
However, the longer the current credit climate continues, the more likely it is that outsourcers will have to consider new ways of raising debt to overcome the reducing availability of banking facilities. As a result, it is entirely feasible that Healthcare Trusts could find it an increasing challenge to identify outsourcers with sufficient funds to take on new large capital projects.
So does this sound the death knell for the outsource industry? Well, no, but it may lead to a new era in which outsourcers and Healthcare Trusts need to work together in a rather different way.
Whereas in the past many outsource providers would have swallowed the cost of investment, tighter margins combined with lack of cheap debt means that outsourcers may now need to consider how they can reduce the impact of significant expenditure at the start of a contract. As a result, Healthcare Trusts may need to work closely with their potential outsource partners to help them realise value in their contracts on which banks can then lend money to cover the cost of the up-front capital investment projects.
The good news is that there are a number of solutions available, ranging from structured loans to receivables based funding solutions, which can be used by outsourcers to raise funds. In both these cases the financier will look to the value of the contract over its lifetime to identify the underlying payment streams within the outsource contract from which they can generate a pool of cash which can be used to fund capital expenditure immediately and in the future.
One way of managing the working partnership between outsource provider and Healthcare Trust is to look to an external financier who can fund the ongoing expenditure by identifying value in the underlying contract. The terms of the payment stream in the contract are key in this respect as they need to provide recognition for the recovery of set-up costs in such a way that enables the funder to attach value. If funders are unable to identify future payments with a degree of certainty they are less likely to be in a position to provide front-loaded finance, so it is very much in the interest of the Healthcare Trusts to find ways that they can include an element of recurring payment to assist the outsourcers in their contracts. One way to do this would be to include minimum guaranteed throughput activity related payments, reviewed on an annual basis. The certainty around this element of the future service payment would allow it to be discounted and provide a present-day value funding sum.
In practical terms this may mean that amendments to financial schedules and contractual terms become more commonplace over the next year. But if Healthcare Trusts are to keep capital costs off their books, a new way of viewing value in outsource contracts may indeed be on the cards. Talking to specialist financiers will smooth this process enabling Healthcare Trusts to focus on the important decisions – such as identifying which outsourcer is best placed to provide the service required and how the relationship with the outsourcer should be managed over the life of the requirement – rather than being concerned about exactly where the cash will come from to finance service critical assets.
