Open Book Contracts – Does the UK Government Have Any Clue About When and How To Use Them?

So I didn't sell my Tesco shares when the current crisis started and now I'm scared to do so, in case I sell right at the bottom, on the grounds that  "things can only get better" for the UK’s largest retailer. Mustn't they?

As we discussed here, and David Atkinson examined in his excellent article, the dodgy accounting seems to have linked with supplier rebates, special payments, display allowances and all the other means by which Tesco appears to both screw additional margin out of their suppliers post-contract award and move money around in terms of timing when profit is "achieved" and booked to the P&L.

So we're all shaking our heads about this, on the grounds that it is unethical / unfair / not good business anyway to agree a contract with a supplier, and then go back later and look for additional payments, lower prices or whatever. There is evidence for example that all that happens eventually is the supplier will charge you higher initial prices, if they know you will be back to eat away at their margin later.

For instance, the Independent newspaper reported suppliers saying they charge competitors such as Aldi and Lidl lower prices than Tesco now, because they know that those firms do honour their contracts. So do we all agree that's not the way to deal with suppliers? Yes? And yet, if you believe some of the comments made by politicians and civil servants, the Tesco approach is exactly what the UK government wants to do in terms of its major suppliers.

This is around the concept of "open-book accounting " which was the flavour of the month recently, being discussed by politicians at the Public Accounts Committee earlier this year, despite the fact I suspect none of them have a clue how you might actually use the technique effectively. My experience is that open-book is a last resort when you face highly imperfect markets and normal competitive arrangements fail, and that’s why the Ministry of Defence use it regularly in single-source contracts particularly - but we’ll come back to that another day.

Anyway, what seemed to be on the table was the idea that "open book" would enable the government to look at an existing supplier and contract, go through the supplier's numbers, and say "we think you're making too much profit. Can we have some back please"?

So is this very different to Tesco's approach? Not really, as far as I can see.

Now I know we are talking about the taxpayer benefiting from this, rather than Tesco, but the principle seems pretty similar. And I don't understand really how it could work. If a supplier has won a contract fair and square, with the best value for money offer, how can you just arbitrarily then demand they cut their margin? Does that mean you would rather buy from an inefficient supplier who is only making a 5% margin compared to an efficient supplier making 15% - even if the one at 15% is cheaper / better value for money?

I really don't get it, and I don't see ethically or practically how it differs from the Tesco approach, and we all know how well that’s gone. I'm a firm believer in competitive markets and processes (VERY competitive markets and processes), strong contract management, benchmarking when it is appropriate ... and so on. But we can't just have an arbitrary arrangement that says the buyer can look at the accounts then decide if and when the supplier is "making too much money" and unilaterally demand reduced prices. (There's also an obvious opportunity for corruption  by the way where a buyer has that power).

Finally, if I have misunderstood the intent here, anyone from PAC, Cabinet Office or elsewhere has an open invitation to write an article here and explain just how it will work. Please, be our guest.

Voices (4)

  1. Reta:

    Open book definitely has a place, and as you point out, MOD has been using it for years when there isn’t a competitive market. But it needs proactive follow through, and deep accounting expertise to analyse the accounts. The belief that it is a good thing in lots of cases is too simplistic. Just imagine a conversation with a supplier “Purchaser: I see from the open book analysis that you made high profit on Contract X; give me a price reduction. Supplier: but on Contract Y I made a loss; will you give me a price increase on that? By the way, my loss on Y is bigger than the gain on X, so you owe me money”. Its beginning to sound like cost plus retrospectively applied, rather than competitive bids and market forces . In other words, there’s more to this than meets the eye, and widespread use isn’t obviously a change for the better.

  2. Andy Morton:

    Open Book can very often lead to mistrust between the supplier and customer. The customer will often be of the mindset (often quite rightly) that the supplier has agreements in the background which are not visible for example retro discounts based on any volume of sales (not target driven)

  3. Secret Squirrel:

    I think there may be some confusion here between the Government and the CCS ‘leadership’. Most of Government does know how to use open book (in exceptional circumstances as you say). CCS and Cabinet Office…not so sure…

  4. Dan:

    I think we should also consider this in conjunction with the recent study by Prof Henke on the value of relationships in the supply chain.

    To summarise: those buyers with better supplier relationships get better value from those suppliers, either from cost reductions or added value (which can often be many times more valuable than cost reductions).

    The kind of actions you are discussing would be damaging to those relationships and would, in the end, cost more than the buyer would gain. I’m kind of surprised that no-one pointed this out to the PAC.

    It may be worth pointing out that open-book costing can be manipulated by the supplier by them doing what Tesco have been doing – moving money around. That being the case, how much value would this add to most contracts?

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