UK Outsourcing Giants Take Diverging Paths | Sherpas in Blue Shirts
Last week both Serco and Capita announced their interim results. Not only did the two companies show a widening gap in terms of financial performance, but they also highlighted diverging business strategies.
Firstly, their financial performance in H2 2014 to date was very different:
- Capita has managed to stay on track to achieving at least 8% organic growth, net of attrition, for the full year 2014 (2013: 8%). It also stated that it expects to maintain its operating margin in the range of 12.5% to 13.5% for the foreseeable future
- In contrast, Serco announced that the 2% organic growth in H1 2014 has turned into a mid-single digit decline in H2. This has been primarily due to reductions in volume of work in the Australian immigration contract but also due to contract losses and reduced volumes elsewhere. Serco expects to shrink significantly by 2016, with revenue reaching a nadir of £3 billion to £3.5 billion from a forecasted adjusted revenue of £4.8 billion in 2014. It expects to return to growth in 2017
- Serco also announced a proposed equity rights issue of up to £550 million in the first quarter of 2015 to strengthen its capital structure
- Capita announced that it has secured £1.63 billion of major new deals to date in 2014 (nine months). This is down by £1.27 billion year-on-year (largely accounted for by the signing of the £1.2 billion O2 mega deal in 2013). At £4.1 billion the bid pipeline is also lower on a sequential basis compared with £5.7 billion announced in July 2014. However Capita reports a strong win rate of one in two
- Serco reported £900 million of contract awards since the half year to date. It also said that its current pipeline and win rate are considerably weaker than before
Secondly, the strategic directions of the two companies are diverging:
- With its strategic review still ongoing, Serco announced that it is going to focus entirely on business to government (B2G) in the areas of justice and immigration, defense, transport, citizen services, and healthcare
- In contrast, Capita aims to grow its private sector business and in particular in the customer management services (CMS) arena. Like Serco, it made a number of CMS acquisitions in the past few years including Ventura and parts of Vertex. Another growth target is its burgeoning legal business with the acquisition of Eclipse Legal Systems. It is also expanding its presence beyond its UK stronghold to countries such as Ireland and Germany
- Serco will be divesting a number of businesses that are now non-core to its strategy. These include the Environmental and Leisure businesses in the UK, Great Southern Rail business in Australia, and the majority of its private sector BPO business which are mostly CMS businesses delivered by two companies that it acquired in recent years: Intelenet and The Listening Company
- Capita has made 13 acquisitions to date in 2014 for £285 million, with more likely as it continues to expand or enhance its capabilities
Interestingly, both companies have also announced changes to their boards:
- Alastair Lyons, Serco’s chairman has resigned
- Capita’s CFO Gordon Hurst is stepping down following a 27-year stint at the company
Serco’s tale of woe began in 2013 when the British government discovered that it had been overcharged by Serco for offender tagging services to the Ministry of Justice (MoJ). The company is still recovering from the fallout more than a year after the issue first came to light, and having repaid more than £68 million of fees and gone through several reviews and management changes. It is ironic that Serco’s new board has chosen to focus on B2G services only, given that the troubles began in a government contract. That said, front line government services is and has always been at the core of the company’s business.
Serco has suffered from failures of governance and risk management. As it rebuilds itself, it will seek to enhance these significantly. In terms of business strategy, it will target growing opportunities in the government sector, as the pressures from aging populations and rising demand for services pushes governments to outsource more. Serco will seek to differentiate itself with its international approach, as part of which it will give its businesses a portfolio of services to go to market within specific regions of the world, to share experience and expertise.
Capita boasts of robust financial and governance structures and highly selective approach to opportunities that it pursues. Robust governance is highly needed given Capita’s aggressive acquisition strategy that has seen it take over more than a dozen companies a year for many years. Even with robust governance problems can still occur. For example, in its eagerness to win more government clients, in 2012 Capita acquired Applied Language Solutions (ALS), which had been awarded responsibility for courts interpreter services in England and Wales. For a while service delivery was less than smooth leading to the MoJ withholding fees in some instances and bad publicity in the press. Overall though Capita has benefited from many niche and strategic acquisitions that it has fully internalized, and which have largely created value and revenue.
There are lessons to be learnt from the performance of the giants of UK outsourcing. Today, one thing that is common to both is the belief that bid and governance structures have to be robust and maintained at all times.