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Select Committee on Trade and Industry Thirteenth Report

4 Barriers to SMEs

52. Government policy has been to "improve small business access to public sector procurement", a responsibility enshrined in the then Small Business Service's key performance indicators.[130] A study by the Small Business Service concluded that there was potential for greater innovation and competition as a result of increased SME involvement in public sector procurement, but it was reluctant to quantify such benefits in the absence of reliable data on the size of government contractors.[131] The FPB, which represents many smaller businesses, argued that government could achieve better value for money and would stimulate innovation by taking action to open more contracts to competition from SMEs.[132]

53. A substantial number of small businesses supply goods and services to the public sector. According to the Federation of Small Businesses, 24% of its members supplied local authorities directly, while the single most prominent purchaser of goods from small manufacturing businesses was the Ministry of Defence. This small business association considered that there was a "healthy participation" by SMEs in public sector procurement.[133] According to the Government's Small Business Service, in 2004/2005, 58% of central government procurement contracts were awarded to SMEs. This amounted to 22% of the total contract value of central government procurement, compared to 18% in the previous year.[134] The FPB suggested that this figure of 22% was insignificant given that 99.8% of businesses were SMEs.[135] We asked the FPB whether the 99.8%/22% comparison was entirely fair, given that many SMEs operated in areas like small-scale retailing or the provision of services to households and did not provide goods or services of the sort or in the quantity that the public sector would procure. The FPB put forward another comparator, that while SMEs accounted for 49.6% of private sector GDP in 2003-04, they won 22% of central government contracts by value.[136] We consider this a fairer comparison.

54. The European Commission published data from 2001 suggesting that the UK gave fewer contracts to micro and small companies than the European average, but around 4% more to medium sized companies. Overall, the UK awarded 15% fewer government contracts to SMEs than the EU average.[137] The FPB compared the UK's performance unfavourably with the USA's, where for the last 60 years public authorities have been required to adopt specific practices designed to increase participation by SMEs in government contracts.[138] However, it is not clear whether the UK's performance is noticeably worse than that of its competitors: the FPB said it was on a par with a number of European countries, and cited the example of France awarding 21% of government contracts to SMEs.[139] The Federation of Small Businesses reported that the UK ranked third in the EU for the number of public sector contracts awarded to SMEs, behind Germany and France.[140] The FPB also admitted that, following changes designed to streamline procurement processes, SME participation had fallen to 23.6% of USA government procurement contracts in 2003.[141] There is also the question of whether like is being compared with like: one of the measures used to define SMEs within the EU is that the company has fewer than 250 employees; but in the USA small business size is defined by comparison to other companies within the sector, with the result that "a manufacturing firm in the United States can have thousands of employees and still be defined as a 'small business'."[142]

55. While there is no doubt considerable room for improvement in the UK's record for the award of government contracts to SMEs, evidence of how it compares with similar countries is mixed. We believe that serious efforts should be made to improve the situation in order to capture the benefits identified by the Small Business Service of greater innovation and competition.

Late payment

56. In addition to bureaucracy, complex pre-tendering requirements, unpredictability of orders, and lack of courage or vision in the taking of procurement decisions (which are problems faced by all types of companies wishing to sell goods or services to the public sector), SMEs, we were told, were specially disadvantaged by some procurement practices. One was the poor record on timely payment of bills by public authorities.[143] The FPB drew our attention to the wide variation in standards throughout the public service: not only were some NHS trusts and certain local authorities significantly worse than others at timely payment of bills (especially in relation to construction projects), but payment practices varied even within government departments, depending on the person in charge of procurement for each contract. The FPB acknowledged that payment practices were not sufficiently bad to deter its members from competing for public service contracts altogether, but they were bad enough to make companies wary of doing business with some public authorities.[144]

57. Government policy has long been that public authorities should set a good example by paying bills promptly — a policy underlined by actions such as the Late Payment of Commercial Debts (Interest) Act 1998.[145] Statistics compiled by the Government show that government departments consistently fail to meet the required standard.[146] There is no excuse for this: apart from questions of justice, such exercise of power by purchasers is likely to deter potential suppliers and diminish competition. It is not clear whether departments' poor performance is attributable to inefficiency on the part of their finance departments or the perverse incentive to retain money owed in order to make their financial position appear better than it is. Whichever is true, HM Treasury has a responsibility for implementing government policy in this area; it needs to adopt a more vigorous approach and it could start by giving a better example itself.

58. While prompt payment would help sustain competition within the procurement process, the FPB made a further recommendation reflecting the fact that maintaining adequate cash-flow is often a problem for SMEs. It suggested that there should be research to determine whether, if practices were changed so that payment could be made incrementally for work in progress, more small businesses would be able to compete for long-term contracts.[147] We consider this idea worth pursuing.

59. The FPB also raised the problem — discussed by our predecessors in relation to the construction industry[148] and acknowledged by the OGC as a continuing feature of that industry[149]— that principal contractors often did not pass on payments to sub-contractors in a proportionate and timely manner. Our predecessors noted considerable variations in the willingness of government departments, and of individual project managers, to insist on contractual provisions requiring contractors to pass on payments to sub-contractors as and when the latter completed their work. The FPB suggested that the National Audit Office should check whether such provisions had been made in any contracts on which it was reporting. The FPB also argued that public authorities had a duty in relation to sub-contractors who were not being paid because, for example, the prime contractor had become insolvent. It suggested that there should be a clause in government contracts to the effect that, in certain defined circumstances, the purchaser could pay amounts owed directly to the sub-contractors.[150] We shall return to this issue in connection with our parallel inquiry into the construction industry.

Support to SMEs

60. The Government's initiatives to encourage SMEs to compete for government contracts included

establishing a website (Supply2Gov) through which lower value contracts (worth less than £100,000) can be accessed. The OGC reported that, since its launch in March 2006, more than 50,000 businesses and over 3,500 public sector authorities had registered, and nearly 50,000 contracts had been published, on the website;

the introduction of a Small Business Concordat for Local Government;

the standardisation of the pre-qualification questionnaire for smaller contracts;[151] and
a training programme, piloted in the West Midlands, for SMEs in the public procurement process.[152]

61. The FPB felt that, while welcome, these developments did not go far enough.[153] It said that SMEs needed more information and training on how to access government contracts, noting that in the USA this was supplied partly through the Small Business Association and partly through the government, which had paid for training for potential suppliers, both small and large. The US government had also required its primary contractors to work with their sub-contractors to improve their understanding of and ability to tender for public contracts.[154] On the other hand, Midlands Fashion Showcase, a regional trade association for the textile and clothing industry, thought there was scope for small specialist contractors to work together on a regional or even inter-regional basis to secure procurement contracts.[155] Other witnesses, such as Amicus, thought that tendering processes might be simplified further by greater use of information technology, though they did not specify which parts of the process could be improved in this way.[156] Conversely, the British Furniture Confederation Public Sector Working Group cautioned against e-auctions on the basis that they precluded any development of a relationship between purchaser and potential supplier, ruling out any possibility of improvements to specification or delivering environmental or other benefits additional to the specification, because they operated merely on the basis of the lowest bid.[157] The OGC argued that e-auctions did not have any effect on specifications or the employment of environmental criteria, etc, because they were undertaken only at the very end of the procurement process, when all other factors had been taken into account and the sole difference between bids was the price. It also pointed out that e-auctions had produced significant savings: in the half dozen or so IT projects that had been subject to e-auctions, savings of 20-50% had been achieved.[158]

62. The FPB proposed other changes: the setting of a target percentage — not, it emphasised, a quota — of government contracts to be awarded to SMEs; 'set asides', limiting tendering for contracts to small businesses where, for example, the small firms in an industry are so economically dependent on one or two large companies that the small companies would be deterred from bidding if the large companies took part; limits on non-competitive tendering (or 'preferred bidders'); more public consultation on procurement regulations; and guidelines on the use of lists of qualified bidders.[159] The FPB argued that several of these, together with provisions enabling 'smart' procurement, would be likely to be ruled illegal under the WTO Agreement on Government Procurement ('AGP'), which was why it considered the UK should seek opt-outs from the AGP.[160] It denied that an opt-out could be equated with simple protectionism: the goal was to give special support to small companies, whatever the nationality of the owner or the country where the goods or services were produced.[161] Nor did it think that any opt-out would have a significant effect on the ability of UK businesses to win public contracts abroad.[162]

63. None of our other witnesses claimed that the AGP formed a significant barrier to adopting practices that might better assist SMEs to compete for public sector contracts. Furthermore, the opportunity for seeking an EU opt-out from provisions of the AGP has now passed. We, therefore, leave the issue of the AGP to one side.

64. The FPB argued vehemently that only a target for the award of contracts to SMEs would suffice to entrench best practice in the many government organisations that have to procure goods and services.[163] It suggested that the target should be set above the current level of participation but below that prevalent in the private sector.[164] The Small Business Service specifically rejected targets for SME involvement, arguing that case-by-case comparisons were a more effective form of analysis.[165] The OGC repeated the Small Business Service's view — that it was impossible to decide what the right level of SME participation was — so, by implication, a target was not only difficult to establish but also unhelpful.[166] In practice SMEs in the UK have almost reached the target set in the USA for SME participation in public procurement — of 23% of direct procurement and 40% of sub-contracted procurement.[167] Also, the target for SME participation in government-procured R&D in the UK has been not only met but exceeded, but it appears that quality — the benefits to the Government and to the companies themselves — has been more difficult to achieve than quantity. We doubt whether the establishment of a target in relation to general procurement would greatly assist small businesses.

SMEs and the Government's efficiency drive

65. We also examined the effects on small businesses of the Gershon programme of efficiency savings, part of which involves the centralisation and rationalisation of procurement. We have already mentioned that the OGC considered the framework approach — the bundling of contracts into larger, longer-term ones — to offer a reduction in bureaucracy and to benefit both government and business. This view was disputed by several organisations. The FPB argued that there might be economies of scale in the short run from centralising procurement, but in the long term, as potential suppliers were squeezed out of the market, there would be less competition in the supply of goods and services to the public sector, with a resulting increase in cost and reduction in quality.[168] The FPB gave an example of where it thought better value for money and greater competition might have ensued from the breaking down, rather than bundling up, of contracts: the provision of 69 regional interview offices for the issue of biometric passports and identity cards.[169] The Federation of Small Businesses also thought that SME participation in procurement contracts would be improved if the UK government imitated the practice of 93% of German and 98% of French public authorities by breaking down contracts into smaller parcels.[170]

66. The National Federation of Builders has recently completed research which measures the impact of the efficiency agenda on SMEs in the construction industry.[171] 460 companies responded, representing 27% of the Federation's membership. About two-thirds of these companies undertook work within the private sector, and a total of 205 companies reported that public sector work represented more than half their turnover.[172] For our purposes, the most significant findings were that while 32% of companies overall reported that there had been a decrease in the volume of public sector work they had undertaken over the last five years, SMEs[173] were more likely to have experienced stagnation or a decrease, while larger companies were more likely to report an increase. All 19 companies that reported they had ceased to work for the public sector in the previous five years had turnovers of less than £10 million a year.[174] For all companies, the most frequently cited cause of a decline in public sector work was "changes in public procurement practices" and the second most frequent was "changes in the volume of public sector work". However, companies with a turnover of less than £500,000 were more likely to think that a decrease in the volume of public sector work was the main reason for the decline.[175] The Federation concluded: "This suggests that relatively smaller enterprises are disproportionately experiencing a decrease in the availability of public sector work, a situation that may have arisen as a result of the drive towards efficiency gains in public sector work (Gershon, 2004), the establishment of frameworks or a re-prioritisation of maintenance and/or small scale projects."[176] Also, despite the belief that frameworks would provide better opportunities for SMEs through sub-contracting, the Federation's findings were that such opportunities "have either not materialised or are not being pursued." Only 59 companies reported that they had worked as sub-contractors within a framework contract. Although 34 of the 59 were companies with a turnover of under £2 million, these were a minority (23%) of all companies with a turnover of less than £2 million that had worked for the public sector.[177]

67. The British Printing Industries Federation was of the view that some approaches designed to speed up procedures hindered rather than helped competition. It said the OGC had established that tenders for print services above the EU threshold typically took 12 months to complete and had developed a different system in which such contracts were broken down into lots below the threshold, and those lots were then subject to competition among companies on a list. The problem from the point of view of the British Printing Industries Federation was that the list comprised only 200 out of the 12,000 print companies and was valid for about four years.[178]

68. Centralising procurement, bundling tenders and seeking economies of scale appear to conflict with the Government's aim of increasing SMEs' access to public procurement contracts. The findings of the National Federation of Builders about the overall decline in SME participation in construction work and the failure of frameworks to provide the sub-contracting opportunities hoped for indicate that it will be difficult to avoid disadvantaging SMEs (and therefore, in the medium term, reducing competition and innovation) as the efficiency drive in procurement goes ahead.

69. The FPB argued: "By far the greatest economic folly committed by government is single-sourcing. It is simply not economic not to seek as many tenders as possible for each and every contract, and yet, in many cases, preferred suppliers are used without the necessary competitive tendering process. Firstly, this discriminates against smaller businesses, and causes misallocation of resources in the economy. Secondly, a lack of or limited competition in the tendering process causes prices to be inefficiently high and wastes taxpayers' money." It added that the Small Business Administration in the USA had advocates working with government departments to ensure that tenders were put out to competition rather than being allocated to a preferred supplier.[179] In contrast, British Expertise thought that other government departments could become much more efficient in procurement if, like the Department for International Development, they allowed desk officers to purchase straightforward items of below a certain value without any form of tendering.[180]

70. Much that the Government has been doing — improving the availability of information about contracts, encouraging local authorities to sign up to the Concordat, training both purchasers and sellers — was considered by our witnesses to be helpful to SMEs, even though in some cases they felt the Government should do more in these respects. There was far less agreement on other avenues that the Government should pursue. In almost every case, any recommendation for changes to procurement practice made by one of our witnesses was opposed by another. Procedures designed to increase efficiency were seen as harming SMEs; attempts to make contracts more accessible to SMEs as slowing down procurement or increasing costs; social clauses and environmental aims as adding bureaucracy; attempts to promote innovation as increasing complexity for the officials who make procurement decisions, or giving 'insider' companies advantages over their competitors. There is clearly a limit to what can be achieved through across-the-board changes to procedures. The focus must be on the way individual decisions are taken. There is no shortage of OGC-sponsored advice and best practice guidance on these issues. Better performance against the Government's objective of increasing SME participation in public procurement therefore depends on two things that we strongly support: better trained and more experienced personnel in charge of procurement, and a change in the emphasis of the OGC from advice to enforcement.

130 DTI's Departmental Annual Report 2006, p 145 Back

131 Small Business Service, A Study of the Benefits of Public Sector Procurement from Small Businesses, 2005, pp 101-103 Back

132 Appendix 25 (FPB) See also Appendix 29 (Leslie Kossoff) Back

133 Appendix 24 Back

134 Small Business Service (2005) Access to Public Procurement for Small and Medium Sized Enterprises Progress Report - December 2005 p. 4 In both cases the statistics exclude Health Service and Ministry of Defence spending. Back

135 Appendix 25 (FPB) See also Appendix 29 (Leslie Kossoff) Back

136 Qq 401-403 Back

137 European Commission (2004) The Access of SMEs to Public Procurement Contracts p. 240-242 Back

138 Some aspects of the USA's approach are discussed in Paragraphs 61, 62 and 64below For details of the USA's procurement policy since 1942, see Appendix 25 Back

139 Appendix 25 Back

140 Appendix 24 Back

141 Appendix 25 (FPB) Back