TO: The Honorable George Allen

and

The General Assembly of Virginia

and

The Small Business Commission

In my capacity as Chairman of the Commonwealth Competition Council, I am pleased to submit the 1997 Annual Report of the Commonwealth Competition Council. The report contained herein is pursuant to § 9-349 of the Code of Virginia as enacted by the 1995 General Assembly and amended and reenacted by the 1997 General Assembly.

This report conveys the findings and recommendations resulting from the Council's work during 1997. The Code requires an annual written report by December 1st to the Governor, the General Assembly, and the Small Business Commission.

Respectfully Submitted,

Otis L. Brown
Chairman

COMMONWEALTH COMPETITION COUNCIL EXECUTIVE SUMMARY

This is the third annual report prepared by the Commonwealth Competition Council to inform the Governor and the General Assembly of Virginia of the Commonwealth Competition Council's findings and recommendations as required by Section 9-349 of the Code of Virginia. For the first time, the report is also addressed to the Small Business Commission as required by Chapter 223, 1997 Acts of Assembly. The report is submitted with the continued expectation that it will be used by state agencies and institutions to foster an element of competition into their activities and to ensure a spirit of innovation and entrepreneurship.

1997 was a "year of transition and training" by the Council and its staff. The Council's 1996 activities and the report thereof formed a major springboard for this 1997 report.

Our 1996 report included the results of a statewide survey of agencies and institutions who provided an inventory of competitive opportunities for the 1998-2000 budget. This data gathering was converted to action with the Council requesting presentations by agencies and institutions covering ninety-one (91) activities. In September 1997, the Council concluded its deliberations and presented its findings to the Governor: twenty (20) opportunities had been transferred to the private sector; thirty-two (32) were not recommended for privatization/competition at this time; sixteen (16) activities were under study or required further evaluation; and twenty-three (23) activities were recommended to the Governor for consideration in the 1998-2000 budget. In addition, the Council revisited the recommendations heard during the 1996 public hearings and forwarded all thirty-three (33) public recommendations to the Governor. The report to the Governor is included in the body of this annual report. The Council also committed evaluation teams to study bookstore operations, fleet management operations, court fine collections, medical center debt collections, and the privatization of child support enforcement offices. Some of these studies are still underway and some aspects will be addressed in the 1998 General Assembly.

In terms of training, 1997 was a very active year for the Council and staff. Numerous presentations, workshops, and privatization/competition symposiums were conducted with state agencies and commissions, governmental entities in Virginia and out of state, professional and civic organizations, foundations, and national associations. In April, the Council co-sponsored with the Thomas Jefferson Institute for Public Policy an "Innovations in Government" conference for state and local government officials. The National Council for Public-Private Partnerships included the Council as a co-sponsor at its October annual conference. The staff trained forty-two (42) personnel on the Council's Cost Comparison Program, ("COMPETE"), including all the budget analysts in the Department of Planning and Budget. Details of these activities and a copy of a "COMPETE" cost comparison program sample are included in the body of this report.

In seeking innovative methods to improve customer service, Senate Joint Resolution No. 284 (1997) requested the Secretary of Administration, in cooperation with the Commonwealth Competition Council, to study methods to privatize appropriate state government functions through the development and promotion of employee stock ownership plans (ESOP). The Council is enthused with the results. The final report will be issued to the Governor and the 1998 General Assembly on December 15, 1997. The executive summary from the report is included herein.

In preparing for the 1998-2000 biennium, the Council encourages the Governor and the l998 General Assembly to maintain the momentum generated from the ESOP study. An effective government transfer to an ESOP can be a "win, win, win" combination for the government, citizens, and government employees.

In transitioning from data gathering, process and program development, to implementation, the Council's privatization/competition program has received national attention. In March 1997, the United States General Accounting Office issued its report "PRIVATIZATION - Lessons Learned by State and Local Governments" to the chairman of the Congressional House Task Force on Privatization. Virginia was recognized as one of the leading states along with Georgia, Massachusetts, Michigan, New York, and the City of Indianapolis. This report includes excerpts from the GAO report. Virginia's reputation was further recognized when the House of Representatives Subcommittee on Government Management, Information, and Technology requested that Virginia be represented at the subcommittee hearings examining H. R. 716/S. 314, the Freedom from Government Competition Act of 1997. This bill injects competition into government activities. Ms. Shirley Ybarra, Deputy Secretary of Transportation, a member of the Council, and as designee of the Governor, provided testimony to the subcommittee on behalf of Virginia. Representative Stephen Horn, chairman of the subcommittee is quoted as saying, "I was impressed with the different laws Virginia has."

In completing this very active and successful year, we are reminded once again of a missing element in striving to provide quality, cost-effective services to our customers - the citizens of Virginia. In the highly competitive private sector, successful and profitable companies foster growth through effective conversion of assets into product and through increased productivity gains and reduced operating costs. The private companies respond to the employee question, what's in it for me? As a result, their employees are rewarded according to the bottom line. In government, the major assets are the employees and their product is service. If government is to maximize its assets, foster entrepreneurial spirit, and seek effective managed competition, then Virginia government should find the answer to "what's in it for me?" Other governmental entities have implemented gain sharing programs to effectively reward employees. As stated in our 1996 report, a gain sharing model should be studied to find an effective way to maximize the knowledge and experience of our work force. There is an old cliche that has merit in this recommendation: "catch me a fish and I'll eat today - teach me to fish and I'll eat forever!"

Virginia enjoys a national reputation for sound financial management. The Council's activities in 1997 have enhanced Virginia's reputation as a leader in the field of government innovation. The recommendations in this report have the potential of providing significant cost savings while maintaining quality services, instilling an entrepreneurial spirit in the work force, and provide the opportunity for state entities to develop the full cost of their operations. The Commonwealth Competition Council embraces the spirit of opportunity in Virginia.

MEMBERS OF THE COMMONWEALTH COMPETITION COUNCIL

STAFF

Mr. Phil K. Bomersheim
Executive Director

Mr. Alan L. Roth
Deputy Director

Ms. Peggy R. Robertson
Executive Assistant

The Council would like to express its appreciation to the following for their continued support:

Senate Committee Operations
Mr. Thomas C. Gilman
Ms. Patty J. Lung
Mr. Brian B. Taylor

Division of Legislative Services
Mr. John A. Garka

and

The Department of Transportation

ANNUAL REPORT OF THE ACTIVITIES, FINDINGS AND RECOMMENDATIONS OF THE COMMONWEALTH COMPETITION COUNCIL

To

The Governor

The General Assembly of Virginia and

The Small Business Commission

Richmond, Virginia

December 1, 1997

I. INTRODUCTION

This is the third annual report of the Commonwealth Competition Council submitted pursuant to § 9-349 of the Code of Virginia. This is the first year the report is also addressed to the Small Business Commission as required by Chapter 223, 1997 Acts of Assembly.

The report is issued to inform the Governor, the General Assembly, and the Small Business Commission of the progress, findings, and recommendations of the Commonwealth Competition Council. It is presented with the expectation that it will assist the Governor and the General Assembly in developing the 1998-2000 biennium budget and communicating the Council's success in implementing an effective privatization/competition program.

The report is presented in five parts:

Part I - This is a detailed sequence of activities of the Council and its staff during the period of December 1996 to November 1997. The Council and staff participated in numerous business round tables, conducted presentations to a variety of public and private organizations, provided assistance in establishing privatization/competition programs to state and local government entities, and conducted extensive training to state managers in the Council's Cost Comparison Program.

Part II - This is a detailed summary of the Council's recommendations submitted to the Governor for assistance in developing the 1998-2000 budget. Part II includes five sections:

Section A - Privatization/competition opportunities for the 1998-2000 biennium;

Section B - Activities currently under study or suggested for study by the Council;

Section C - Activities not recommended by the Council for privatization at this time;

Section D - Privatization/competition opportunities recommended in the 1996 Annual Report that have been privatized or competed;

Section E - Privatization/competition activities recommended by Virginia citizens and businesses at the Council's four 1996 public hearings.

Part III - Excerpts from the United States General Accounting Office report: Privatization: Lessons Learned by State and Local Governments.

Part IV - The executive summary from the employee stock ownership plan (ESOP) study final report.

Part V - A copy of the Council's Cost Comparison Program ("COMPETE").

II. THE PRIVATIZATION/COMPETITION PROCESS

In 1996 the Council approved a five-step privatization/competition process which is a systematic approach to determine what government functions and activities are opportunities for both internal and external competition and represent potential transfers to the private sector. The process is shown in Attachment 1. In order to effectively make the recommendations in this report, the Council collected input from public hearings, testimony from state agencies and institutions, unsolicited proposals, and a statewide survey of state agencies and institutions during the latter part of 1996. This input resulted in an inventory of privatization/competition opportunities. These opportunities were revisited and further considered by the Council this year to arrive at the recommendations presented herein. Part II in the body of this report is a detailed summary of the Council's findings and recommendations submitted to the Governor. The next steps in the privatization/competition process are discussed below.

Virginia's privatization/competition process and related programs received national recognition this year. The United States General Accounting Office highlighted Virginia's success in a March 1997 national report studying the lessons learned in select states and cities. The program's success was reaffirmed in September when a member of the Council was asked to present Virginia's program to a Congressional subcommittee studying effective ways to privatize more government services. Representative Stephen Horn, chairman of the Subcommittee on Government Management, Information, and Technology, is quoted as saying "I was impressed with the different laws Virginia has," whose subcommittee is studying H. R. 716, the Freedom From Government Competition Act of 1997. Part III of this report provides excerpts from the GAO study.

III. EMPLOYEE STOCK OWNERSHIP (ESOP) STUDY

As requested by Senate Joint Resolution No. 284 (1997), the Council in cooperation with the Secretary of Administration, played an extensive role in the research, development, and preparation of the final report for the Governor and the 1998 General Assembly. SJR No. 284 required a study of the methods to privatize appropriate state government functions through the development and promotion of employee-owned companies. The research indicates that Virginia is the only state government to have undertaken a study of this nature. Since SJR No. 284 did not require that specific services or functions be identified for an ESOP privatization, the next step should be a pre-assessment and feasibility study to determine ESOP candidates. A successful implementation of an ESOP privatization can be a "win, win, win" conversion for the state, citizens, and employees. The executive summary from the final ESOP report is shown in Part IV.

IV. FINDINGS & OBSERVATIONS

Privatization/competition in not always an easy course of business considering the political and constituent issues facing both state and private sector managers. The Council has remained steadfast in ensuring that, through education and training, advancements can be made in bringing both sectors closer to agreement on approaches and results. The Council continues to address the enablers, hurdles, and incentives impacting state managers and private sector representatives to conclude a business transaction which leaves both sides with a positive sense of accomplishment for themselves and the state's taxpayers. Privatization/competition has become a worldwide phenomenon largely due to its ability to improve performance and reduce the cost of government.

What is the role of competition in the privatization process? Competition is the engine that creates the savings and efficiencies associated with privatization. Privatization itself does not yield annual operating savings. It is the change in organizational performance, which results from being subjected to a competitive environment, that yields the savings. Privatization is simply the process of getting there. Therefore, any successful privatization initiative must consider the competitive environment. Governments with successful competitive programs refer to them as managed competition programs, and usually there is a gain sharing incentive program supporting the managed competition endeavors.

For privatization to be truly successful, competition must be introduced. Competition will in turn force a more efficient government by focusing management on effectively utilizing all their physical assets, disposing of those no longer needed, and maximizing employee productivity.

The intent of an effective competitive environment will not be maximized if the nature of the state culture continuous the status quo. It is unrealistic for state managers to be committed to reducing the size and cost of government if, by doing so, such action means the end of their careers. Whether anachronistic or better provided by the private sector, state managers see little or no incentive to move forward. From the ability to maintain some of the proceeds from a privatization to continue further efficiency initiatives, to pension portability, representatives of both the public and private sectors acknowledge that a specific set of incentives needs to be formalized and accepted by executive and legislative leadership.

Managers and staff should be allowed flexibility to create innovative financial transactions, and be rewarded accordingly, without undue concern over whether the transaction will be approved based on only a short-term financial horizon.

These findings and observations lead to two significant points: (a) the requirement to develop the fully allocated cost of state services to compare with private sector costs and (b) the incentivation of the competitive process to maximize our most valuable producible asset - the government workforce - to encourage them to effectively compete with the private sector. Both these points have relativity to the recommendations below.

V. FULLY ALLOCATED COST OF SERVICES

Typically, governmental budgeting is basically a cash flow exercise. It results in estimating the current revenues needed to meet the current cash requirements to perform a service. The budget does not answer an essential question - What is the full cost of operating a function or service? The full cost of a function or service includes all direct operating costs plus capital asset depreciation costs, indirect costs, and overhead costs, including both operations and general and administrative overhead. The development of fully allocated costs is a necessary decision-making step in the Council's privatization/competition process in order to determine whether a function or service should remain in-house or be transferred to the private sector.

The Council has a developed an automated Cost Comparison Program ("COMPETE"), to determine the fully allocated cost of government services which can be compared to the cost of providing the same service by the private sector. This program also has the capability of computing the per unit cost of activities within a function or service. An example of the cost comparison program is shown in Part V.

VI. MANAGED COMPETITION

Managed competition has a relationship with fully allocated costs. In the orderly course of events, a service or function that is considered an opportunity for privatization/competition should establish performance work statements, develop its fully allocated costs, and solicit proposals from the private sector to determine the private sector cost of providing the service. Since the agency has developed its fully allocated cost (not the budget cost), it now has the opportunity to reengineer and submit its own most efficient organization proposal to compete with the private sector proposals. This is managed competition - effectively managing agency costs to compete with private entities.

Governmental entities that have implemented successful managed competition programs have provided incentives for their work force with gain sharing programs. Gain sharing is best explained by example: the current fully allocated cost of a service is $200,000; solicitations for both public and private proposals produces a private sector cost proposal to provide the service for $150,000; the agency's reengineered proposal is the same $150,000 private sector cost, and is awarded the contract. At the end of the first year the audited figures verify that the agency performed the service for only $125,000. The $25,000 difference, or a portion thereof, between the agency's original proposal and the actual audited cost, is the gain sharing amount rewarded to the agency, to be distributed in accordance with the guidelines of the gain sharing program.

With gain sharing, the state realizes a net savings of $25,000, or more, which would not have occurred absent the gain sharing program, which provided the stimuli for management and staff to compete.

VII. RECOMMENDATIONS

As stated earlier, the Council has developed the inventory of opportunities, considered those that represent potentially viable candidates for privatization/competition, and has submitted them to the Governor for his consideration in the 1998-2000 budget. As noted in this report, the costs associated with these services are not fully allocated costs nor has it been determined whether there is sufficient private sector capability to perform the services. The next steps in the budget process should require agencies to conduct public/private analyses, develop the fully allocated cost of the services, prepare the performance work statements, and issue solicitations for proposals. Funding should not be unalloted until these steps are fully exercised.

The Council recommends that each of the 23 privatization/competition opportunities included in this report be associated with budget item language requiring the steps mentioned above in order to complete the full process. The Council has developed the financial tools to perform these steps and will work with the agencies to assist them in completing the process.

Pertaining to the ESOP study, we encourage the Governor and the General Assembly to sustain the momentum generated from the ESOP study and proceed with the recommendations included in that final report.

Lastly, the experts confirm that competition is the engine that creates the savings and efficiencies associated with privatization. To foster an effective managed competition program, there should be a reward system. The Council recommends that the Governor and General Assembly include a requirement in the 1998-2000 budget directing the appropriate agency to conduct a study on how to implement a viable, cost-effective gain sharing incentive program.

VIII. CONCLUSIONS

Virginia enjoys a national reputation for sound financial management. The Council's activities in 1997 have enhanced Virginia's reputation as a leader in the field of government innovation and financial management. Both the recommendations made above and the privatization/competition opportunities recommended in this report have the potential of providing significant cost savings while maintaining quality services, embracing the spirit of opportunity for the work force, and the challenge for state entities to develop the full cost of their operations.

Respectfully submitted,

Otis L.Brown, Chairman

Walter A. Stosch, Vice Chairman

John B. Adams, Jr.

Theron J. Bell

Walter P. Conrad, Jr.

Hudnall R. Croasdale

V. Earl Dickinson

Douglas W. Domenech

Michael E. Thomas

Shirley J. Ybarra