On her majesty's shrinking service

Jim Marsh's face fell when he totted up June's trading figures. After listening to George Osborne, the British chancellor, talk tough about spending cuts in his emergency budget on June 22, the chief executive of Cable & Wireless Worldwide had expected his growing public sector business would suffer — but not this much, or so quickly.

At a stroke, the government had virtually turned off the tap on discretionary telecom spending, cancelling orders for extra internet bandwidth and putting office moves on hold.

It was income that CWW had grown accustomed to over the past year, and enough to force a shock profits warning last Tuesday that drove down the group's shares.

"We clearly underestimated one aspect," John Pluthero, CWW chairman, confessed to shareholders at the annual meeting a day later. "The incoming ministers knew little about the programmes that have been running and the issues and options that exist, so their first action was to stop everything and take stock."

Contractors, from Hewlett-Packard to IBM and Capita to BT, initially brushed off fears they would lose out in a purge led by Francis Maude, the Cabinet Office minister.

The only way the government could force through 25 departmental budget cuts over three years was if they outsourced more work to the specialists, not less. But if there is a carrot of extra business being dangled before them, all the companies feel right now is the stick that is prodding them to volunteer austerity measures. CWW, which derives only 12 of its turnover from the public sector, was never meant to be hit this hard.

"Everyone is moving into uncharted territory here," said Anthony Miller, managing partner at Tech Market View, the technology analyst. "This is the first time government departments have been asked to plan for such dramatic cuts." Microsoft found that out last week when the NHS decided against renewing an enterprise-wide contract covering servers and desktop software.

More shocking was the ousting of Raytheon, the US defence company that has been trying to make inroads into civilian IT contracts. Ministers conceded weeks ago that e-borders, a project to create a secure border control system to get to grips with immigration, needed to be rethought.

Soak up spending

But comments that Theresa May, the home secretary, had "no confidence" in Raytheon struck at the heart of contractors who have been soaking up public spending for years.

The early pruning has been taking place against a backdrop of one-to-one meetings between Maude and the government's top 19 suppliers.

"Make no mistake, we will have to take some tough decisions and for the major suppliers we are looking for savings across their portfolios," said Maude. "I have made it clear that some has to come off margins and the rest from descoping the contracts.

"This is about a fundamental re-look at the way companies provide services to government but there will be benefits for both sides."

Bosses have been told to turn up with their top five ideas for saving money. Extending contracts in exchange for a reduced upfront price is not an option. "They are telling us they want to move really quickly," said one chief executive. "If they like what we bring to them, they plan to have a memorandum of understanding drawn up within two weeks."

With margins undoubtedly under pressure, it promises to be a long, hot summer for those firms that count the government as their biggest customer. Before autumn, it might not be just CWW that bears the scars.

If this really is the time to think the unthinkable, contractors would prefer to dream about the opportunities that could come their way, instead of how they must scale back existing work.

Take the National Health Service (NHS). A decision on what happens next to the National Programme for IT — the much-maligned £12.7 billion (Dh73 billion) project to link up patient records electronically — is still to be taken despite a white paper published this month on the future of the NHS.

Meanwhile, companies such as Capita predict that the health market, which accounts for only 4 per cent of its turnover, is rich with opportunity. Barely any of the functions of the NHS's back office have been outsourced. Capita has taken over the processing of payments to dentists for work carried out on NHS contracts in England and Wales. It expects to drive down the cost of handling 40 million dental forms and payments totalling £2.5 billion by up to 40 per cent.

Neil Griffiths, the business development director at Capita, estimates that the NHS's remaining centralised activities — such as managing pensions, health insurance cards and call centres — cost close to £4.5 billion a year.

In local NHS trusts, Griffiths believes that 20 per cent of the costs and a similar proportion of staff are involved in administration. The biggest of these is "front office" — in other words, hospital reception desks, appointment bookings and various clerical activities. For so long a back-office specialist, Capita is itching to go front of house. "NHS patients would find their local hospitals much easier to contact by phone, email or text and much more responsive to those contacts," said Griffiths. "The second additional benefit is to remove much of the administrative burden from front-line clinical staff — allowing them to focus on patient care."

The NHS budget has doubled to £105 billion in the past decade. Unlike many other government departments that face an immediate spending freeze, its income will carry on increasing in real terms.

However, the demands of an ageing population will outstrip supply. The King's Fund, a health care think tank, predicts that unless cuts are made, by 2014 the NHS will face a £14 billion productivity gap — the difference between the likely available funding for the NHS and the level of funding required to achieve the progress projected by Sir Derek Wanless in his 2002 report for the Treasury.

Steria, another outsourcer, has made strides at a local level. NHS Shared Business Services, a joint venture between the NHS and Steria, provides accounting and personnel services to 130 trusts. However, John Torrie, UK boss of the French-owned group, complained recently that the venture was legally blocked from signing up other public bodies as customers.

Selling technology to the public sector to improve productivity is also popular. Advanced Computer Software, run by Vin Murria, the chief executive, boasts that its iNurse handsets enable community nurses to ditch the paper trail of note-taking and let them fit in an extra two home visits a day.

Behind all the talk of cuts that will take place this year and next lies Maude's vision.

Contractors may be eyeing bags more work, but the government has its own agenda.

"In these negotiations we will also explore constructive ideas on how we can structure services in a different way so that we all benefit in the future," Maude said.

Imitating private sector

At its heart, politicians want to imitate the private sector, using the government's scale to wring better deals from suppliers.

Currently, there is a divide-and-conquer mentality. Each department has its own fiefdom, managing payroll, administration and contact with the taxpayer in its own way. There is limited common use of communications networks, desktop computers and digital storage.

Experts believe that the government spends about £18 billion a year on information technology alone. Half of that is for central government, yet buying decisions are typically devolved to each department.

That is expected to change. John Suffolk, the chief information officer, will have his role beefed up from a purely advisory one, enabling him to intervene in costly buying decisions on an ad hoc basis.

He will report to Ian Watmore, the former Accenture boss, who arrives as the chief operating officer of the efficiency and reform group in September after an unhappy spell leading the Football Association. On his watch, the buzz words will be standardisation and simplification.

"This is not about the centre trying to micro-manage the details of individual departments' business," said Martin Read, the former Logica boss who also sits on the government's efficiency and reform group.

"It is about ensuring that money is no longer spent inefficiently on duplication and inconsistent and incompatible purchasing."

Some bosses are sceptical that changes can be forced through. "I have worked to sell services to most of the government departments for years and whatever central procurement has been attempted, it has never worked," said one seasoned chief executive.

"Decision-making just gets passed down to the departments."

Other changes are on the cards. Government advisers worry that if they do turn over so much work to the private sector, it would help if there was a greater choice of companies to hand it to.

Companies such as Capita and Serco — which runs everything from the Docklands Light Railway in London to prisons and the government's umbrella advice organisation for business, Business Link — dominate the market.

Capita alone already commands 27 per cent in the overall business process outsourcing market — which includes private sector work — according to analysis by Ovum. That is up from 25.5 per cent last year.

To create more choice, government "shared service" centres are under consideration. At its most extreme, the government could roll the back offices of various departments together, inject some private equity funds and commercial management. That way ministers could create another competitor that is capable of tendering for business.

As conversations over trimming spending continue, perhaps the sunny horizons that outsourcers are predicting could soon be overcast by more than the odd thunderstorm after all.