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CHAPTER SEVEN THE COSTS AND IMPLICATIONS OF FCR IMPLEMENTATION

Introduction

7.1 The earlier Chapters have looked in some detail at various aspects of FCR, from the stand points of the voluntary and the public sectors. What emerges is that:-

• FCR is complex and there are no easy answers;
• There is general agreement that, were it to be implemented, it would not be cost neutral;
• Many in the public sector, especially local government, would be unwilling to implement it because of the perceived costs involved and the feeling that it might make the voluntary sector become complacent;
• Many in the voluntary sector are sceptical about FCR being implemented. If it was implemented the view is that it would be unlikely to result in all of the sector being fully funded;
• The larger organisations in the sector already seem to be moving towards FCR; and
• Others "muddle through" and recoup their full costs by a mixture of cross subsidy and drawing on reserves.

7.2 Against this background the purpose of this Chapter is to do two things:-

• Give an estimate of the likely costs of the implementation of FCR; and
• Outline a number of FCR scenarios.

The costs of implementing FCR

7.3 The survey respondents claimed that they were subsidising public sector contracts to the total value of £2,550,835 (Table 3.21). This level of subsidy amounts to 0.96% of the respondents' total income of £264 million. This represents 10% of the sector's income in 2004, assuming that SCVO's estimate of the sector's total income of £2.62 billion is accurate ( SCVO, 2005). One could use these figures to undertake some calculations of the cost of implementing FCR. For example, assuming that the survey respondents are representative of the sector within Scotland, then:-

• Given that the sector's total income is estimated to be £2.62 billion then the total extent of underfunding of services bought from the sector is 0.96% of this, that is £25.2 million a year; alternatively
• As the survey respondents account for 10% of the sector's income then the estimated level of underfunding is £25.5 million (10 X £2,550,835), 0.97% of total income.

7.4 However, in order to account for any bias in the survey sample there is a need to:-

• Correct the sample distribution across the income bands so that it is representative of the population of voluntary organisations; and
• Factor the distribution up to the total size of the sector so that a more realistic estimate of the costs of implementing FCR in Scotland can be arrived at.

Both of these processes are not without their problems, mainly caused by the quality of the data on the "shape" of the sector within Scotland.

7.5 Data on the distribution of income to voluntary organisations can be found in SCVO's Voluntary Sector Database and also in the data collected by the Office of the Scottish Charities Regulator ( OSCR). Table 7.1 compares the income distribution of the survey sample to that of the 7,740 organisations for which SCVO has income data and the 16,038 charities that supplied data to OSCR. Two things emerge:-

• The sample is biased towards larger organisations. Indeed, this bias was deliberate in that it was felt that FCR was unlikely to be of much interest to the many very small organisations within the sector. Accordingly the sample was deliberately skewed towards organisations with incomes in excess of £25,001; and
• Both SCVO's and OSCR's data has the same distribution of organisations across the income bands. This gives a degree of confidence that the distribution is reasonably accurate.

Table 7.1 Voluntary Sector organisations' income breakdown (Column Percentages)

Note:-
1. The population data is derived from SCVO's Voluntary Sector Database which contains income data for 7,740 voluntary and charitable organisations within Scotland. The extent to which this is representative of the sector as a whole is not known.
2. The OSCR data is derived from the validated returns made by 16,038 charities. It was derived from three sources: personal communication with the Regulator to obtain a breakdown of the number of organisations in the two highest income bands; and the two OSCR publications "Scottish Charities 2005" ( OSCR, 2005) and "Scottish Charities 2005: additional data" ( OSCR, 2006).
3. The SCVO Database breaks income bands into the "Up to £25,000" and "£25,001 to £100,000" categories. Of the 7,740 organisations, 69% fell into the "Up to £25,000" band and 15% into the "£25,001 to £100,000".

7.6 Having identified the income distribution of voluntary organisations it is now necessary to derive some estimate of the total number of organisations within Scotland. Different sources give different estimates. For example:-

• SCVO estimates that the sector consist of 50,000 organisations. Of these 25,700 are said to be regulated in that they are charities or mutual organisations ( SCVO, 2005); or
• OSCR, in its 2005 Report ( OSCR, 2005) has data for 16,038 charities.

7.7 Both sources are problematic for the purposes of this exercise. For example:-

• Not only is it unclear as to how SCVO arrived at a figure of 50,000 organisations, but many of these are very small. For example, 69% had incomes of less than £25,000 (Table 7.1). As such it seems likely that FCR will be far less of an issue for them than for the larger organisations. Indeed the sample was structured on this assumption (Paragraph 3.1); and
• The Regulator's data relates only to charities and currently does not include all cross-border charities that operate in Scotland (although some are included). However, it may be that such charities, which are likely to be large, are already adept at recovering their full costs. As such their omission may not have a significant impact upon any FCR calculations.

7.8 One way to reconcile these differences is to assume that the OSCR data is a sub-set of SCVO's. If SCVO's 50,000 estimate is accepted then those organisations with incomes of £25,000 can be subtracted from this total. The assumption is that FCR will be largely irrelevant to them. These organisations are small, either run by volunteers or a part-time coordinator and are reliant upon a single source of funding (Scottish Executive, 2005b, Annex E). However, if FCR does prove to be an issue for these small organisations then this assumption may need to be revisited. Subtracting these small organisations from SCVO's 50,000 gives a population of voluntary organisations with incomes in excess of £25,000 of 15,500. This is assumed to be the number of organisations upon which FCR will have an impact and is used in the subsequent calculations in this Chapter. However, we will use the OSCR figures for the number of organisations with incomes in the top two income brackets (£500,001 to £1,000,000 and in excess of £1,000,000). As the numbers are based on validated returns these seem likely to be more reliable than SCVO's estimates of the numbers in the sector that fall into these higher income brackets.

7.9 Our subsequent calculations are accordingly based upon 15,500 organisations and the income distribution across the income bands shown in Table 7.1. Table 7.2 shows the average subsidy levels for organisations in each of the income bands.

Table 7.2 Average FCR subsidy levels

7.10 We can then use the average level of subsidy to estimate the gross cost of implementing FCR. This is shown in Table 7.3. It can be seen that the estimated level of underfunding of the sector, and accordingly the direct cost of implementing FCR, is £118 million, or 4.5% of the sector's estimated gross income.

Table 7.3 The gross cost of implementing FCR

7.11 The calculations in this section are based on a number of assumptions that can be challenged. However, we have tried to make the calculations, and the assumptions on which they are based, transparent. One reason for doing this is that we would argue that there is no easy or "correct" way to estimate the costs of FCR implementation. The data is often partial and at times suspect. However, as the quality of data improves (for example through the addition of all cross-border charities into OSCR's data) the estimates can be revisited and updated. Given this, our "best" estimate is that the direct costs of implementing FCR (that is the additional costs of service delivery) within Scotland are £118.497 million. Based on the sample size the margins of error are +/- 10%, that is between £106.55 million and £130.25 million. This ranges from 4.1% to 5.0% of the sector's total income. This is at the bottom end of the Big Lottery Fund's estimate of the costs of implementing its FCR strategy ( Chapter 6).

7.12 These ranges are based on the sector's own estimates of the extent of underfunding. Whilst this might be seen as a methodological flaw, it seems unlikely that more accurate estimates can be easily, and economically, calculated. We will now turn to look at some scenarios that might come about were FCR to be implemented.

FCR scenarios

7.13 As in all scenario-setting exercises the scope for outlining different outcomes is almost infinite . Despite this we feel that it is worthwhile outlining some possible outcomes that might arise.

7.14 If the status quo is maintained then it seems likely that the trends that are already evident in the sector will continue, with organisations falling into three groups:-

7.15 The danger of this outcome for the public sector is that some medium to large organisations decide that they are no longer willing to subsidise services and therefore withdraw. If these services are a statutory responsibility, this could place public funders in a difficult position, as well as reducing the diversity of services on offer. Alternatively, if the larger bodies succeed in getting their full costs, then this may mean that the medium to small organisations are squeezed and face funding cut backs. This might result in a loss of diversity in the sector.

7.16 Once we move away from the status quo then any scenarios become dependent upon a number of other decisions being made. Essentially there are three areas where strategic decisions need to be made. These are:-

• How FCR is to be funded;
• The types of funding relationships that FCR should apply to; and
• What items of expenditure should be covered by FCR and at what level?

7.17 In terms of funding scenarios a number of alternatives can be identified:-

• The Executive increases grant aid to public bodies on an ongoing basis to cover the costs of implementation, with the expectation that this money will be then passed onto voluntary organisations;
• The Executive decides that the costs should be shared between itself and public bodies on, for example, a 70:30 basis;
• It is decided that the full costs will be factored down by a proportion to account for efficiency savings. The resultant sum is then either fully funded by the Executive or shared between it and public bodies; and
• It is decided that FCR will be cost neutral, with additional costs having to be met from efficiency savings in both public bodies and the sector.

7.18 There are no doubt other scenarios. However, with the exception of the first, all of the others would seem to imply varying degrees of "pain" for public bodies and the sector.

7.19 There is then a need to consider the types of funding relationships that FCR should be applied to. Again alternatives can be outlined:-

• It could be argued that explicit, detailed FCR should not be applicable to competitive tendering. If nothing else this would give parity with the way the private sector is treated. In such a situation it is up to the contractor to calculate a cost. This may be based on full costs or it might not if, for example, there was a desire to enter a new market and it was felt worthwhile making an initial investment for longer term gains. Clearly, over the medium to long term, organisations have to cover their costs (in effect have to practice FCR) otherwise they may go out of business. Yet they may not want to do this on a contract by contract basis;
• Service Level Agreements ( SLAs), whereby a contract is entered into to provide a minimum level of service for a fee. In principle SLAs would seem to be suitable for the application of FCR. However, there is an issue as to the treatment of SLAs by the public sector. In a number of instances, both in the Focus Groups and the Case Studies, examples were given of SLAs that were treated by the funder as grants. There is also an issue as to how prescriptive SLAs are, with some being deliberately kept vague so that creativity and innovation are not stifled. In such instances the SLA would seem to be more akin to a grant ; and
• Grants, which theoretically are given to an organisation in return for providing a service but without the level of this service being tightly prescribed. It could be argued that these should not be subject to FCR in so far as there is no contractual relationship between the two parties. Yet this ignores the reality whereby some organisations receive the majority of their funding in the form of grants which can amount to quite sizeable sums of money (see, for example, the NSF case study, Chapter 6). In these instances it seems as if grants tend to be treated almost as SLAs.

7.20 Given this it would seem that there is no easy answer as to the type of funding relationship that FCR should be applied to, if only as the funding reality is often at odds with the theory. Therefore there would seem to be a need for commonly accepted definitions to be agreed, and then used, across Scotland prior to any decision being made as to the implementation of FCR.

7.21 Finally there is a need to consider what costs should be covered and at what level. One option might be for the public sector to simply accept a statement of an organisation's costs as being its full costs and then pay these. This is unlikely to happen as Chapter 4 indicated. Accordingly, there would be a need to get agreement as to what costs should be legitimate for FCR to cover. By implication these might not be an organisation's full costs. Chapter 4 (Paragraph 4.18) gives a list of what might be included in FCR. However, it is hard to envisage a situation where such a list could be agreed by the entire sector and all of Scotland's public bodies. Even if such a list could be agreed, there is then the issue of what are permissible costs (or percentages) to set against each item. Setting some sort of "norm" would seem to be almost impossible, given the sector's diversity. It is this very diversity that could then see the transparency that FCR implies resulting in continuing discussions as to what are acceptable costs. This might be less of an issue with those costs relating directly to service delivery. However, there may be scope for considerable argument over core costs.

7.22 Despite the degree of uncertainty over these strategic areas we have attempted, in Table 7.4, to outline a number of alternative scenarios, for each of which the positive and negative consequences have been outlined. Overall what emerges is that the implementation of FCR seems, with the exception of the scenario in which FCR is fully funded (and the additional resource is passed onto the sector), to impact adversely upon some organisations in the sector. Whilst this may be seen as unduly pessimistic, the reality may be that the sector will fragment with the larger organisations providing statutory services receiving full costs, the small, locally based organisations continuing to be grant aided, whilst the medium sized organisations face funding cut backs in order to allow full costs to be provided to others.

7.23 There are also other issues that need to be considered in the context of FCR, in particular partnership.

Partnership

7.24 Theoretically there is partnership between the sector and public authorities in the delivery of services. The reality is, as has been highlighted in many places in the earlier text, that this partnership is very unequal. That this is so reflects both on the voluntary and the public sectors.

7.25 The voluntary sector seems willing to place itself in a subservient position and, for the most part, to accept reduced funding whilst continuing to provide services, even when these may have to be cross subsidised in a variety of ways. This reflects what was termed by Focus Group attendees as the "voluntary sector ethos" (Paragraph 4.11).

7.26 That parts of the public sector seems happy to accept this cross subsidy and indeed, almost to expect it, may reflect a degree of indifference to voluntary organisations that is typified by the "take-it-or-leave-it" attitude to funding. This indifference would seem to be bred by the sector's willingness to accept this situation.

7.27 Given that both parties seem to be at fault it would seem that, if there is to be effective partnership, then voluntary organisations need to be willing to say "no". This characterises a number of the voluntary case studies, where there has been a willingness to stop providing a service if the money being offered was not enough to cover costs. This may be the only way to redress the balance and ensure that relationships between the voluntary and the public sectors are placed on a more equal footing.

Conclusion

7.28 Full cost recovery seems, in principle, to be both desirable and fair. The financial costs of its implementation seem relatively modest. However, implementation would be against a background of public bodies being forced to make efficiency savings. As such they seem unlikely to be willing to increase the amount they give to the sector without some comparable evidence of cost savings. There must also be a danger of FCR becoming a bureaucratic nightmare with no grants or SLAs being allocated without there first being a detailed scrutiny of costs and debate over the validity of these. Given this, explicit implementation (in contrast to the implicit implementation that currently seems to be going on with some of the larger organisations in the sector) may be a high risk strategy that could see the diversity of the sector put at risk as well as setting different parts of the sector against one another.

7.29 Despite this rather pessimistic assessment the Executive has a commitment to recognising the need for itself and other public bodies to pay full costs in service contracts. Accordingly the final Chapter outlines a number of action points that need to be taken account of if this commitment is to be met.

Table 7.4 Full Cost Recovery scenarios

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