Gareth Morgan: Don't let big suppliers drag us down

A government taskforce concluded there was a need for partial private ownership of state-owned enterprises in New Zealand.

Underlying the recommendation by the Capital Markets Development Taskforce was the recognition that these organisations comprise an inordinately large share of our business sector, and their performance is material to national achievement.

This is creating a drag on national productivity, which also applies to government departments and to our large, monopolistic private companies.

So what might be the causes of this drag?

It starts with the cringe factor - endemic among New Zealand's journeyman managers who think that because something is from America, or it's promoted by multinationals, it must be superior to local solutions.

The types of IT supplier failures referenced in this column last week are normally reserved for government departments or state-owned enterprises (SOEs).

Managers in these outfits remain in awe of the big names in the IT game when they embark on projects. And that blindsight paves the way for abnormal profits and underwhelming value for the customer.

How is it that the IT procurement people of these SOEs, government departments and big firms can adhere to a serially deficient, budget-busting approach to technological change?

Why are they in awe? Their first handicap is that they act like trustees for shareholders or taxpayers, seeking primarily to ensure things don't go wrong, rather than seeking the best, profit-maximising solution.

This is a big difference in objectives. The sub-optimality of the trustee model is something I have highlighted in the financial market as well.

In a situation where you should be maximising profit (or in the case of a government department, social benefit) for given risk, trustee-type thinking should not prevail.

Trustees are all about minimising risk - irrespective of how high the cost of that strategy to the ultimate beneficiary. Trustees are not incentivised to count the cost of eliminating risk, they simply have an infinite appetite for avoiding blame - commonly called butt-covering.

The second factor is that too often those making the purchasing decision are insufficiently competent. They are just not skilled enough for the specific task or procurement.

Their job spec has them covering a wide range of tasks of which this is just one. How often do you hear heads of government departments say they are insufficiently resourced?

And being of a trustee mentality - not having their own wealth at stake - they fall for the well known, international brand syndrome. "No one ever got fired for choosing IBM."

That is why they instinctively go for big international brands, instead of doing the evaluation competently.

This behaviour aligns with a third common element, that being the government procurement policy which encourages the use of big foreign suppliers.

The truth is there are local providers of service and equipment that can do a better job than the foreign-owned multinationals.

They unfortunately do not have the marketing budget to wine and dine the customer nor can they match the lure of offering the international conference that provides so-called knowledge transfer.

The susceptibility of customers to baubles of the deal is a well-established marketing idiom.

This technique is the standard offering the marketers of multinationals make to middle managers, inducements honed to perfection and subtlety with the purpose of seducing the journeyman execs with an "exciting" break from the office.

The locals cannot match the promises from such suppliers.

These multinational suppliers make a point of studying and understanding government procurement processes all over the world - to the point where they have developed sophisticated cynical models of the behaviour of mandarins and boards of these types of customer.

Central to those models is the reality that even with the potential of high liquidated damages (for non-delivery or non-performance) the supplier has full confidence that the humiliation of public exposure or failure is just too great for most SOE board members to contemplate.

They will always cave in to variations or a final deal that avoids publicity.

Such a reality opens the door for smart multinational corporate folk to talk their way through to final selection.

In too many cases their submission can be based around "vapourware" software solutions or products that do not exist, but sound good and meet the specification requirements.

They will still get the nod, and the truth is too often that the supplier will produce the "solution" on the fly and use the paying project to fund their product development.

By focusing on the technical weakness inherent within the job specification that the client has signed off on, and forcing variation to contracts as they work their way through, even though the supplier knew at the start that they could not meet timeframes and delivery targets, the multinational easily arm-wrestles the hapless customer to fund excess profitability.

These projects follow the same pattern over and over again, they become five to six times over budget - a $20 million project can turn into a $120 million one.

The supplier knows that walking away is not an option for these clients.

They know that the board will eventually swallow the pill, the variation will be agreed and the project will be sold as a "success" within the organisation.

To do anything else would see board members lose face.

In most cases the end solution is adequate. Only the projects that totally fail no matter how much money has been thrown at them hit the headlines.

But it is a total rip-off as far as the taxpayer or shareholder is concerned, and also for the small competitive suppliers that comprise the local economy.

In many instances they would have done the job on time, and to budget. But the mandarins' procedures are designed to exclude the small local player. With so much of our economy in SOEs and government departments the economic costs are large to New Zealand.

The multinationals live on an international stage and can afford any ill-will from a New Zealand SOE or government department.

They simply move on to another international customer, knowing they can return at a later date once the chief executive of the organisation has moved, or a major restructure has occurred.

For New Zealand we lose the ability to build local businesses and retain talent.

A large part of our economy is destined to miss out on the productivity and economic efficiency gains necessary to stop our continual slide down the OECD league tables.

If Prime Minister John Key is serious about invoking a "step change" in the way our economy performs, as a step on the way to closing the gap with Australia, say, he could do a lot worse than have his new Productivity Commission hear the numerous case studies of SOEs and government departments that have fallen for this sucker's game with the multinationals and introduce changes to level the playing field.

For example, it would be relatively simple to re-specify the procurement policy of all government departments and SOEs to buy local unless they can prove the ability to fulfil doesn't exist.

That would be a far more difficult task for the mandarins to cock up than presuming locals can't and multinationals can. Board composition of SOEs is a second problem.

Look at many of the SOE boards and ask yourself what practical experience members bring.

It's easy to see the rewards of service for former politicians that apparently include SOE board memberships - but these folk are far from suited to the demands of the job.

In all, we have a large part of our economy in the state or state-owned sector.

Productivity improvement will prove elusive with its rules of engagement with the private sector undergoing a "step change".

* Gareth Morgan is director of Gareth Morgan Investments.