Political mud is being thrown everywhere this week, but the reality is that successive governments have bought into this vision, which is why for many years the shares of outsourcers were seen as such a good bet – what, after all, is better than a taxpayer-funded annuity? Even as it stumbled towards liquidation – a rare fate for companies of Carillion’s size – the government was awarding it new contracts, perhaps lulling investors into a false sense of security that a recovery could be engineered.
Yet there is an old rule that applies to pretty much everything in life, but especially to investing, which is that if something sounds too good to be true, then it probably is. And the reductive description of outsourcing that I offer certainly falls into this category. Carillion’s collapse may turn out to be the specific result of mismanagement, but the struggles of former stock market darlings such as Mitie and Capita have showed us that the shine was coming off the outsourcing model. In short, it is much harder to make money from it than many previously believed.
The introduction of new accounting rule IFRS 15 – a revenue recognition measure – is likely to make it harder still. But at least it will mean the kind of accounting trickery that has obscured the build up to the all-too-regular collapse of outsourcing companies should in future be much easier to spot. Simple logic, meanwhile, should continue to warn us away from the idea of outsourcing as a universally-beneficial panacea – to win business, outsourcing firms have been forced to underbid the true cost of delivering services, or rather overstated just how much more efficient they could make their delivery. With a few notable exceptions, outsourcing should be low-margin work that commands no investment premium.
The tempting conclusion for those of a more left-leaning political persuasion is that the kind of work these outsourcers are doing should revert to the public sector entirely. But in a modern capitalist economy where the lines between public and private have become so blurred such suggestions are specious at best – outsourcing is here to stay. What’s more, the hostility to outsourcing is also very likely to translate into investor aversion, and that could mean shares in those companies that either have a defensible niche or know how to turn low margins into high profits could suddenly look very attractive.
