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Variations in the organization of contractual relations with private
contractors: Transactional, organizational and strategic determinants
Andrej Christian Lindholst,
Department of Political Science, Aalborg University, October, 2016
Draft prepared for presentation at annual meeting at the Danish Political Science Association,
Vejle, 2016
Early work – Must not be cited
Introduction
Systematic and large-scale involvements of the private sector in public service delivery systems
through market and contract-based arrangements, i.e. contracting out, has today become widespread
in most OECD countries as part of ongoing reform initiatives and searches for public sector
improvements (Vincent-Jones, 2000; Boyne, 2003; Greve & Ejersbo, 2005; Kettl, 2010).
The involvement of the private sector in public service delivery has been well-researched in
terms of public authorities‘ ‗make or buy‘ choices between internal service delivery and contracting
out as well as other discrete organizational alternatives, such as non-profit organizations or other
governmental providers (Boyne, 1998; Brown & Potoski, 2003; Bel & Fageda, 2009; Hefetz &
Warner, 2012; Rodrigues et al., 2012; Sundell & Lapuente, 2012; Petersen et al., 2015; Foged,
2016). Recently, the choice has also been addressed as a ‗make and buy‘ choice in terms of why
public authorities chose to rely on both internal and external delivery for a particular service or what
have been referred to as ‗concurrent sourcing‘ or ‗mixed delivery‘ (Warner & Hefetz, 2008;
Rosenberg-Hansen et al., 2011; Hefetz et al., 2014).
However, beyond the choice of make and/or buy between various discrete organisational
alternatives, some research has also highlighted a multitude of variations in how contract-based
exchange relations, i.e. the choice of buy, are organized when the private sector becomes involved
in public service delivery. Over the years research has addressed, for example, the use of different
coordinating mechanisms, such as markets, hierarchies and networks (Sarapuua & Lembera, 2015),
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the reliance on trust (Davis & Walker, 1997; Brown et al., 2007; Lamothe & Lamothe, 2012), the
importance of relational governance (Walker & Davis, 1999; Fernandez, 2009), the role of and
impact on contract management capacity (Kettl, 1993; Romzek & Johnston, 2002; Van Slyke &
Hammons, 2003), variations in instruments, approaches and arrangements (Lindholst, 2009), the
differentiated use of hard and soft contracts (Greve & Ejersbo, 2005), alignment of values,
institutions and markets (Brown et al., 2006), the importance of different design choices for
performance (Shetterly, 2000; Fernandez, 2007; Fernandez, 2009) and shifts from competitive
toward collaborative models (Sullivan & Skelcher, 2002; Entwistle & Martin, 2005) as well as
needs for development of models congruent with democratic requirements for ongoing deliberation
(Vincent-Jones, 2007) in contract-based exchange relations and contractual governance involving
the private sector.
The diverse and only partly interrelated research stream addressing variations in the
organization of contract-based exchange relations have rearranged the question of make or/and buy
into a range of sub-questions about how the buy option are organized within a public sector context.
One key recurrent sub-question or theme in the research stream is the design of and reliance on
formal contract features in contract-based exchange relations. While the importance of formal
contract features has been prompted by several scholars still relatively little is known, however,
about why public authorities opt for different formal contract designs in their exchange relations
with private contractors. The objective of this study is to explore and explain variations in formal
contracts implemented by public authorities for regulating their exchange relations with private
contractors.
The remainder of the article proceeds by firstly exploring contract theory and elaborating a
range of hypotheses on why public authorities opt for different contract designs. The hypotheses
relates to the importance for contract design of key transactional, organizational and strategic
characteristics. The hypotheses are tested on a dataset based on survey and register-based sources.
The survey-based data stems from a survey of midlevel managers in municipal road and park
departments in Danish municipalities while the register-based data stems from official municipal
accounts. Two key response variables are constructed from eight survey items which measures the
emphasis on different formal contract features in municipal exchange relations with private
providers of road and park maintenance. The two response variables refer to respectively
‗transactional‘ and ‗adaptive‘ dimensions in the formal contract framework. The main analysis is
based on two hierarchical ordinary least square regressions where hypothesized relations are
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explored through assessment of the importance of six predictors against the two response variables.
Findings from the analysis is subsequently evaluated and discussed. Finally, the conclusion
summarizes key findings, some limitations and implications for further research.
Why public authorities opt for different contract designs
This section starts out by presenting a conceptual framework for understanding contractual
relations. The framework emphasizes respectively transactional and adaptive functions in contract
based exchange relations which are reflected in various degrees in the formal contract design. The
section then develops a set of hypotheses regarding the circumstances under which respectively
transactional and adaptive functions are emphasized in formal contracts.
Overall, the theoretical framework follows the discriminating alignment hypothesis, as
stated by Williamson, (1991, p. 277), which holds that transactions, which differ in their attributes,
are aligned with governance structures, which differ in their costs and competencies, in a
discriminating way. The discriminating alignment hypothesis is also found inherent in the research
agenda by Brown et al. (2006) suggesting that effective management (and research) of service
delivery in the hollow state requires consideration (and alignment) of the characteristics of public
values (e.g. public preferences and purposes with contracting out), institutions (e.g. organizational
and legal arrangements) and service markets (e.g. cost of contracting).
Formal contracts and their transactional and adaptive functions
Contracts are essential instruments for regulating economic exchange (Milgrom & Roberts, 1992).
Seen from an institutional and organizational perspective contracting out implies formation of and
reliance on inter-organizational exchange relations regulated by a degree of formalized and legally
binding agreements, i.e. contracts, between buyers and sellers of services. Such contracts can be
designed very differently, support a variety of government functions and integrate behaviours based
on both legal (e.g. laws or court decisions) and non-legal (e.g. industry standards) institutions
(Vincent-Jones, 2000; 2007). The use of formal contracts in exchange relations can, for example,
range from very short and simple agreements, stated in a one-page document to bulky and detailed
sets of documents including, for example, technical specifications, juridical matters, liabilities, or
descriptions of project organization.
Contracts furthermore have multiple functions in the regulation of inter-organizational
exchange relations. Sociological accounts of contract theory have emphasized the core function of
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the contract, not through its characteristics as a legally binding agreement, but as a mechanism for
‗projecting exchange into the future‘ which govern most modern real-life exchange relations
(Macneil, 1974; 1980). Accordingly, agency theory and transaction cost theory has emphasised the
need to structure contracts in cost minimising ways as mechanisms for safeguarding exchange
relations from various risks and hazards arising from a number of transactional (e.g. unforeseen
contingencies and asset specificity) and behavioural (e.g. bounded rationality and opportunism)
characteristics. Contract theory (including transaction cost theory) also emphasizes the function of
the contract as a mechanism in ongoing exchange relations for guiding coordination between
partners and adapting exchanges to internal and external change (Schepker et al., 2014). For the
purpose of this paper the corresponding formal contract features which support the two key
functions identified by contract theory are referred to as transactional contract features (TCF) and
adaptive contract features (ACF).
Transactional characteristics
The importance of transactional characteristics of economic exchange for optimal choice of contract
design has long been highlighted within economic perspectives on economic organization (Milgrom
& Roberts, 1992). In particular, standard assumptions on bounded rationality (which render most
contracts incomplete) and opportunism as basic characteristics of human actions explicate the need
to build-in various contractual safeguards in exchange relations. Under these two assumptions it is
the human capacity for conscious foresight (as a third assumption) that allows parties to an
exchange relation to design contractual agreements purposefully to mitigate potential hazards.
Accordingly to Williamson: “Parties to a contract who look ahead, recognize potential hazards,
work out the contractual ramifications, and fold these into the ex ante contractual agreement
obviously enjoy advantages over those who are myopic or take their chances and knock on
wood.”(2000, p. 601). Several attributes of an economic exchange (the transaction) actualize the
need to use foresight and design contractual agreements in concordance. In a ‗truncated‘ analysis,
Williamson (1991) emphasize three critical attributes in terms of frequency, uncertainty and asset
specificity of involved transactions as sources of contractual hazards and co-determinants of
efficient contractual arrangements. In particular, increasing complexity, in terms of foreseen and
unforeseen contingences an exchange relation needs to handle, increases the need to build in further
contractual features – or shift to vertical integration (Milgrom & Roberts, 1992). Similarly, in the
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literature on contracting out in the public sector ‗complexity‘ has also been associated with needs to
detail further contractual features (Brown et al., 2016).
Based on the arguments above, it is found that greater complexity in the transactional
attributes of an exchange relation requires incorporation of additional contractual features which
regulates contingencies. Contractual features may take the form of more detailed specifications of
technical requirements and service descriptions, more encompassing monitoring and sanctioning
systems or juridical clauses. Greater complexity may, furthermore, also lead to the need for the
contract to facilitate information sharing, communication and collaboration as well as detail the
parties‘ roles and responsibilities in order to provide rational planning, mitigate risks resulting from
uncertainty and adapt to unforeseen contingencies (Schepker et al., 2014).
First hypothesis (H1): Greater complexity in the involvement of private contractors is positively
associated with emphasis on more elaborative formalized transactional contract features (H1a) and
adaptive contract features (H1b).
Organisational characteristics
One defining feature of public management reforms in the last three decades is the introduction of
organisational models based on features such as arm-length principles, disaggregation, use of
service standards, performance targets and monitoring systems (Hood, 1991). One requirement for
organizational models based on such features is the formalization of market-like exchange relations
between internal organizational units.
However, municipalities may combine external and internal service provision and
implement different mixes of organizational models in search of exploitations of the advantages –
and avoidances of disadvantages – of each model (Parmigiani, 2007; Rosenberg-Hansen et al.,
2011; Hefetz et al., 2014). According to Williamson (1991), one comparative advantage of
organizational models based on hierarchical relations is the relatively easy access to continuous
adaptation (of service provisions) to internal and external change. However, the drawback is a more
costly and resource-demanding mode of organization. On the other hand, organizational models
based on market-based relations have their advantage in ensuring cost-efficient modes of
organization – but if implemented at the extreme – at the expense of capabilities to undertake
continuous adaptations within the contract.
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Those municipalities where market based-models of coordination is implemented in a
comparatively fuller scale in external as well as internal relations may therefore need to develop
adaptive features within their exchange relations to a higher degree than those municipalities where
a more pronounced mix of hierarchy and market-based is implemented. In the former case, the
municipality must combine both transactional and adaptive features in their exchange relations with
external (as well as internal) service providers. In the latter case, the municipality can exploit the
adaptive capabilities of a hierarchical organisation of the internal service provision while still
exploiting the advantages of market-based external relations. In this case, the municipality only
need to develop transactional features (for competitive and safeguarding purposes) in their
exchange relations with external service providers.
Second hypothesis (H2): Differences in hierarchical integration of in-house operational capabilities
is not associated with differences in formalized transactional contract features in external exchange
relations.
Third hypothesis (H3): A low (or no) hierarchical integration of in-house operational capabilities is
positively associated with more formalized adaptive contract features in external exchange
relations.
The capability view on organizations sees organizations as a set of embedded capabilities in terms
of skills and routines which are not easily transferred across organizational boundaries (Nelson &
Winter, 1973; Nelson & Winter, 1982; Becker, 2004). Congruently, it can be argued that contracts
and the choice of contracts do not come ‗out of nowhere‘ and elaborating and managing a contract
requires involvement of specialized expertise – or ―contract design capabilities‖ (Mayer & Argyres,
2004; Argyres & Mayer, 2007). The development of management capacity and expertise in
contracting processes in the public sector has similarly been highlighted by Kettl (1993) and Van
Slyke and Hammons (2003). The argument here is that lack of such capabilities, i.e. expertise,
would render an organization inapt to use formal contracts as a governance mechanism for
regulating exchange relations as well as inapt to elaborate and adapt contractual frameworks to
particular needs. It follows that higher degrees of internally organized contracting expertise should
result in a greater reliance on formal contract features in exchange relations.
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Fourth hypothesis (H4): Greater internal contracting expertise is positively associated with higher
emphasis on more elaborate formal transactional and adaptive contract features.
Alternatively or as an augmentation to elaborating contract frameworks through reliance on internal
expertise a municipality may also rely on involvement of specialized expertise from external
advisors or consultants. Organizational analysis based on sociological accounts of institutionalism
(DiMaggio & Powell, 1983) highlights the role of management consultants in the diffusion of new
ideas and concepts within organizational fields. In particular, management consultants, as
professional actors, carry organizational models between organizations which not only disseminate
the use of certain standards within an organizational field, but also contribute to local adaption,
improvisation and translation (Furusten, 2009). Following the arguments above, it can be assumed
that involvement of external expertise may help the organisation to import new ideas and concepts
and tailoring formal contract frameworks to the needs of the organisation.
Fifth hypothesis (H5): Greater involvement of external expertise is positively associated with higher
emphasis on an overall more elaborative formal contract framework.
Strategic purpose of contracting out
The conventional understanding in the literature on contracting out in the public sector has framed
the contract as a set of features shaped to fit the purpose of maximizing economic effects from
competition, i.e. minimizing overall costs (Donahue, 1989; Domberger & Jensen, 1997; Greve &
Ejersbo, 2005). Contract features associated with specification and accountability has in particular
been highlighted as important. Emphasis on low cost as contracting objective may result in
increasing problems with other important contractual objectives such as service quality in terms of
‗quality-shading‘ (Hart et al., 1997). Higher degrees of contractual completeness are argued to limit
the potential for opportunism and improve performance (Shelanski & Klein, 1995; Macher &
Richman, 2008). Following the arguments above, it is argued emphasis on low cost as contracting
objective is associated with more elaborate transaction contract features. The reason is that
emphasis on transactional features supports low costs as a contracting objective by enhancing an
effective use of competition as well as mitigating the accentuated contractual hazards from quality-
shading effects.
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Sixth hypothesis (H6): greater emphasis on low maintenance costs as purpose for contracting out is
positively associated with more elaborative transactional contract features.
In contrast to the conventional approach to contracting out, organized around the logic of
competition, approaches organized around a collaborative logic have been introduced throughout
the 2000s and 2010s. In contrast to the purpose inherent in the conventional approach, the purpose
of implementing a collaborative logic in contracting out is associated with transformation,
development and governance rather than provision of standard services at lowest possible cost
(Sullivan & Skelcher, 2002; Entwistle & Martin, 2005). From the viewpoint of contract theory
(Vincent-Jones, 2007), the support of a collaborative logic in an exchange relations entails a
different set of formal contract features. In particular the formal contract must be designed to
support ongoing interactions between the contracting parties.
Seventh hypothesis (H7): greater emphasis on development/learning as purpose for contracting out
is positively associated with more elaborative adaptive contract features.
Overall, the seven hypotheses address the importance of key transactional (H1), organizational (H2-
H5) and strategic (H6-H7) characteristics for municipalities‘ emphasis on respectively transactional
and adaptive contract features in their exchange relations with private contractors.
Methods
Context of study
The national context of the study is the municipal park and road sector in Denmark. The municipal
sector in Denmark is organised in 98 municipalities with holds decentralized responsibilities for
various social and technical services. Contracting choices within a particular service area is usually
– and by tradition – delegated to each municipality, but cohesive instruments for promotion of
private sector involvement, such as binding targets for the percent of budget spends on private
contractors and compulsory use of private contractors for some services, have to some degree been
implemented by central government policies.
The municipal park and road sector in Denmark has since the early 1990s undergone
significant organizational changes driven by public management reforms (Lindholst et al., 2016).
Municipal park and road departments, formerly organised as hierarchies with integrated
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responsibilities for planning, management and operations, have been disaggregated into
organizational units with separated responsibilities. In the same token, operational responsibilities
for respectively park and road services have been merged and integrated within the same units,
competitive tendering and contracting out have become widespread and common service and
contract standards have been developed. Common standards in support of conventional
(transactional) approaches to contracting out became available in the 1990s while, common
standards in support of collaborative (partnership) approaches became available in the 2000s.
According to national statistics, the level of contracting out of park and road maintenance was in
2015 around 40 % measured by the share of budget spending on private contractors – a level
significantly higher than the overall average for all municipal services (26 %). The economic
significance of park and road services equals approximately 4 % of all expenditures on municipal
services in Denmark.
Key characteristics of park and road services, in terms of their relatively ease of
specification and measurability, are furthermore found in a few studies to render the two services
relatively well-suited for contracting out vis-à-vis other services (Brown & Potoski, 2005; Levin &
Tadelis, 2010; Hefetz & Warner, 2012). Detailed case-studies, however, have also shown that
contract implementation is complex, challenging and involves very different managerial strategies
(Lindholst & Bogetoft, 2011).
Data
Data-wise the main analysis in the study draws on a combination of items from a larger survey in
combination with register-based data. The survey was carried out in the period 2014-2015 and
contained more than 65 main questions related to planning, organisation, management and
performance of internal (i.e. organized in-house) and external arrangements (e.g. contracts with for-
profit organizations) for delivery of maintenance services in the municipal park and road sector in
Denmark. The survey was sent out to mid-level managers in park and road departments in all 98
Danish municipalities and returned a total response-rate of useable entries of 77 % (equal to 75
municipalities) of which 89 % (equal to 67 municipalities) indicated that they used private
contractors in some degree for the provision of park and road maintenance services. The full dataset
was found to be representative for all Danish municipalities according to size, geographical location
and expenditures on private contractors for provision of park and road maintenance.i The register-
based data comprised municipal accounts on expenditures on private contractors for maintenance
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operations typically organized as part of the responsibilities of municipal park and road
departments.
Variables
Details of the construction of all variables in the study, including formulation and measurement of
survey items as well as data used for register based variables, are reported in Table 1.
Table 1. Construction of variables
Variable Construction Survey items b / data sources
Measurement scale
Transactional contract features (TCF)
Composite index, 4 survey items (Alpha = .870)
Specify on a scale of 0 to 10 the degree to which the following content is central in your relation with private contractor(s) for maintaining parks and green spaces and/ or roads:
Formalized and written legal clauses (e.g. a signed contract).
Performance specifications – describing overall goals, functionality and guidelines for operation and development.
Prescriptive specifications – based on quantities, instructions and performance measures.
Formal sanctions (e.g. financial penalties) for noncompliance.
0-10 a
Adaptive contract features (ACF)
Composite index, 4 survey items (Alpha = .764)
Specify on a scale of 0 to 10 the degree to which the following content is central in your relation with private contractor(s) for maintaining parks and green
spaces and/ or roads:
Agreement on close collaboration and joint planning of operations and development.
Agreement for contractors to involve / liaise directly with citizens and users.
Agreement on extended economic framework with incentives for investments, optimisations or improvements.
Competence requirements (e.g. professional affiliation or qualification).
0-10 a
Transactional complexity
Proxy variable based on calculations of annual expenditure (DKK) on private provision of park and road maintenance services
Data source: Statistics Denmark. Distribution of underlying data for value of economic value is strongly left skewed. Data is transformed into natural logarithmic (LN) values. Descriptives for original data: mean = DKK 45.2 mill, min-max = DKK 4.6 – 271.5 mill.
LN
Dept. responsibilities as provider
Dummy variable based on a single survey item
What role does your department have, and which functions are they responsible for?
Practical delivery (e.g. contractor role / day to day maintenance)
0=no, 1=yes
Internal contracting capability
Composite index, 4 survey items (Alpha = .810)
Specify on a scale of 0 to 10 the degree to which you think that the following statements describe your department's capacity to manage private contractor(s)
We have sufficient organisational resources (e.g. time and staff)
We have sufficient experience and expertise
We have sufficient methods and systems (e.g. quality standards, GIS and ICT systems)
Our management practices and procedures are sufficient.
0-10 a
External advice / consultants
Single survey item Specify on a scale of 0 to 10 the degree to which you think that the following methods are used when you procure maintenance services:
Advice from external consultants/advisors
0-10 a
Contracting purpose: Low costs
Single survey item Specify on a scale of 0 to 10 the degree to which you find that the following purposes are a key part of the municipality’s considerations for using private contractors for the services your department has responsibility for:
The purpose is to ensure low maintenance cost.
0-10 a
Contracting purpose: Development/learning
Composite, 2 survey items (Alpha = .843)
Specify on a scale of 0 to 10 the degree to which you find that the following purposes are a key part of the municipality’s considerations for using private contractors for the services your department has responsibility for:
Develop services and areas.
Develop our methods and routines.
0-10 a
a Item(s) measured on an 11-point response scale with end anchors where 0 = ‘not at all’ and 10 = ‘very high degree’.
b Translates from Danish.
The study includes two response variables which measure the level of respectively transactional and
adaptive features in formalized contract frameworks found within the context of park and road
maintenance in Danish municipalities. The two response variables are composite constructs based
on eight survey items (see Table 1 for wording). The eight survey items were derived from
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inspection of available contract standards available in the Danish park and road sectors as well as
aligned with earlier research on prevalent contract features in the park and road sector (Lindholst,
2009). Four items were constructed to measure transactional features and four items were
constructed to measure adaptive features. The internal consistency (reliability) of the two constructs
was checked by inspection of values for Cronbach‘s alpha. The alpha value was good for items
included in the first factor (alpha = .870) while moderate for items included in the second factor
(alpha =.764). Values for alpha could furthermore not be improved by removing any items included
in the two extracted factors. A principal component analysis (PCA) was carried out with the aim to
check for discriminant validity of the two composite constructs (see appendix for diagnostics). Main
results from the analysis are shown in Table 2. Two components with eigenvalues above 1
explained a total of 67 % of the total inter-item variance. The first component, labeled „formalized
transactional contract features‟ (TCF), explained approximately 53 % of the variance while the
second component, ‗formalized adaptive contract features‟ (ACF), explained approximately 14 %
of the variance. The correlation between the two components‘ scores was .501.
Table 2. Principal component analysis for 8 survey items on formalized contract features: Factor loadings and communalities
Survey items a
Primary factor loadings and communalities b
Formalized transactional contract features (TCF)
Formalized adaptive contract features (ACT)
Communalities
Juridical clauses / agreement (§§) .930 .791
Service specification based on functionality and purpose .679 .650
Service specification based on quantities, instruction and performance measures
.917 .771
Formal sanctions in case of non-compliance .777 .749
Formal collaboration and joint planning (.301) .562 .577
Contractor’s involvement / contact with users .774 .600
Economic incentives for investment, improvements and optimization .898 .710
Competence requirements .668 .523
a See Table 1 for translated wording og survey items.
b N = 64 (list-wise) Two components extracted with oblimin rotation (Eigenvalues > 1). Factor loadings below .3 are not shown. Secondary factor
loadings in brackets. Solution extracted in 6 iterations.
The degree of transactional complexity in a municipality‘s relations with its private contractors is
operationalized by a register-based measure for the absolute economic value of the municipality‘s
involvement of private contractors (expenditure on private contractors). Larger economic
involvements in the park and road sector commonly include a greater number of works – as well as
different types of work – to be carried out, more work sites distributed across a given geography,
needs for more unilateral as well as bilateral planning and coordination, greater risks, higher levels
of required capital investments (staff, site location, machinery, production facilities and so on), a
greater number of sub-contractors and support functions, a greater number of potential stakeholders
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(e.g. landowners or utility companies), more contingencies which need to be addressed and so on –
all aspects which adds up to a greater transactional complexity which need to be managed and
coordinated in the contractual relation. Data for the size of expenditure on private contractors was
calculated from available municipal accounts (register-based) on park and road maintenance. The
calculation included responsibilities for all maintenance services typically delegated to municipal
park and road departments in Denmark, including different types of parks and open spaces as well
as transport infrastructure.
The variable for the level of hierarchical integration is measured by two single binary items
indicating whether a department held operational responsibilities as internal provider of park and
road maintenance services. The variable corresponds to two different levels of hierarchical
organizational integration of operational responsibilities. Park and road departments with no
responsibilities correspond to situations with low (or no) integration while those with
responsibilities corresponds to a situation with a relatively higher level of hierarchical integration.
The variable for internal contracting capability was constructed from four single items each
measuring the sufficiency of different aspects of a department‘s contract management capability.
The variable has a high inter-item reliability (alpha = .810) which could not be improved by
removal of any single item. The variable for involvement of external expertise is measured by a
single survey item addressing the degree to which advice from external consultants/advisors is used
by the municipality in procurement of park and road services.
The variables for contracting purposes are measured by different items in the same survey
question. The variable for low maintenance cost as contracting purpose is measured by a single item
while the variable for development/learning is a composite construct based on two survey items
(alpha = .843).
Data analysis
An initial analysis explores findings based on descriptive statistics as well as bivariate associations
between all variables. The study‘s main analysis relies on two multivariate analyses based on
hierarchical OLS (ordinary least square) regressions. The first multivariate analysis explores the six
predictors‘ importance for the level of transactional contract features (TCF). The second
multivariate analysis explores the six predictors‘ importance for the level of adaptive contract
features (ACF). Diagnostics for heteroscedasticity and collinearity as well as for influential outliers
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were carried out. No influential outliers were found and inspection for heteroscedasticy and
collinearity found no substantial issues.
Model evaluation
Biases potentially inherent in survey-based research (Podsakoff et al., 2003) were sought minimized
through ex ante remedies as well as post hoc tests were carried out to gauge eventual influence of
any substantial amount of common method variance. Ex ante remedies in the design phase
included: use of input from pilot test for design and exact wording of survey items, selection of
respondents due to their supposed insights in the survey‘s main topic, as well as anonymity and
confidentiality at the level of respondents and municipalities. Furthermore, the two response
variables did not rely on sensitive self-reported performance evaluations (Meier & O'Toole, 2013).
Finally, the survey data was combined with register-based data on municipal expenditures (for one
predictor).
Harman‘s single factor test was used for post hoc check of common method variance. The
test was carried out with all survey based variables included in respectively the analysis with
transactional contract features and the analysis with adaptive contract features as response variables.
In both tests, all survey based constructs were included in un-rotated principal component analyses
in order to gauge the influence of any substantial common method variance. In both tests, the
analysis resulted in three distinct components with eigenvalues greater than 1.0 rather than a single
dominant factor. No components in the two analysis accounted for more than 26 % percent of the
total variance. Statistics furthermore indicated a poor fit of the data for the two principal component
analyses (Kaiser-Meyer-Olkin measure for sampling adequacy < .500). The post hoc statistics
indicate that (a substantial amount of) common method variance is not likely to be present and
confound the interpretation of findings.
Findings
Table 3 provides an overview over descriptives and bivariate correlations for all variables included
in the final analysis. The values for standard deviations for the two response variables, transactional
and adaptive contract features, indicate substantial inter-municipal variations. The mean values for
the two variables also indicate that the average emphasis on transactional contract features is
substantial higher (mean = 7.5) than the emphasis on adaptive contract features (mean = 4.9).
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Table 3. Descriptive and bivariate correlation matrix
Variables Descriptives Bivariate correlations (Pearson’s)
N Min-Max Mean S.D. 1 2 3 4 5 6 7 8
1. Transactional contract features
57 2.0–10.0 7.5 2.1 -
2. Adaptive contract features
57 .5–10.0 4.9 2.0 .527 ** -
3. Transactional complexity (LN)
58 8.4–12.5 10.4 .7 .370 ** .324 * -
4. Hierarchical integration of operational resp.
58 0–1 .67 .5 ÷.234 † ÷.256 † ÷.042ns -
5. Internal contracting capability
58 3.3–10.0 6.9 1.6 .315 * .205 ns .265 * ÷.039 ns -
6. Use of external advice / consultants
58 0–10 6.2 2.5 .300 * .236 † ÷.203 ns ÷.072 ns ÷.045 ns -
7. Contracting purpose: Low costs
58 0–10 7.5 2.0 .079 ns ÷.152 ns ÷.194 ns ÷.299 * ÷.169 ns .061 ns -
8. Contracting purpose: Development/learning
58 0.0–8.5 5.0 2.1 .052 ns .370 ** .132 ns .082 ns .067 ns .014 ns ÷.022 ns -
N (listwise) = 56
Significance levels: † p < .1, * p < .05, ** p <.01, ns = non-significant.
The underlying data used as proxy for measuring the level of transactional complexity
shows a huge variation in the size of expenditure among Danish municipalities on maintenance
services provided by private contractors. The average expenditure is DKK 45.2 million (equal to €6
million), but the variation ranges from a minimum of DKK 4.6 million (equal to €600,000) to a
maximum of DKK 271.5 million (equal to €36.4 million). Overall, the underlying data is
characterized by a strong right skewness, i.e. a few municipalities have very high values for
expenditure compared to the majority.
About two-third of the municipalities have park and road departments with direct
responsibility as internal provider of maintenance services. The other one-third has either no direct
responsibility for internal provision or the municipality use private contractors for provision of all
park and road maintenance services. The underlying survey data also shows that 8 out of the 58
municipalities (equal to 14 percent) contract out all park and road maintenance services (‗total
contracting‘). The remaining 50 municipalities have a combination of in-house and external service
provision, i.e. a degree of concurrent contracting.ii Only 11 out of the 50 municipalities, which use a
degree of concurrent contracting, have park and road departments with no direct responsibilities as
municipal provider of park and road services. Overall, the data indicate that the majority of Danish
municipal park and road departments have integrated direct operational responsibilities and have
direct access to internal operational expertise through hierarchy.
The mean values for the level of internal contracting capabilities and use of external advice /
consultants are almost similar (respectively 6.9 and 6.2). However, the variation measured by
standard deviations for the use of external advice / consultants (S.D. = 2.5) are substantial higher
15
than for the variations in the level of internal contracting capabilities (S.D. = 1.6). The values for
the (high) variation in the involvement of external advice / consultants indicates that some
municipalities only use external advice / consultants in a very limited extent while other
municipalities relies more heavily on external advice / consultants.
The mean values for the contracting purposes related to respectively low maintenance costs
(mean = 7.5) and development/learning (mean = 5.0) differs substantially and on the average low
maintenance cost has a substantial greater emphasis as contracting purpose compared to
development/learning as contracting purpose. While, the difference is unsurprising given the
general framing of contracting out in public policies as a strategy to reduce costs of public service
provision, there are, however, substantial variations among municipalities in the emphasis of both
purposes as well as the mean value for development/learning as contracting purpose indicates that
development/learning is not unimportant. In particular some municipalities have a relatively high
emphasis on development/learning as contracting purpose.
The bivariate correlations indicate several potential associations of theoretical interest.
While the overall level of transactional and adaptive contract features differs they are still strongly
correlated (Pearson‘s = .527, p <. 01), i.e. higher levels of adaptive contract features are associated
with higher levels of transactional contract features. The finding supports the understanding of the
two contractual dimensions as interwoven (and not mutually exclusive). The two response variables
are furthermore substantially correlated with several, but not all, predictors. Higher levels of
expenditure are significantly associated with higher levels of respectively transactional and adaptive
contract features, i.e. municipalities which have a higher absolute economic value in their
engagement with private contractors also implement more elaborate contract frameworks than
municipalities which have a lower value. Departments which have direct responsibilities as provider
of maintenance services also implement significantly lower levels of both transactional and adaptive
contract features in their exchange relations with private contractors. A higher level of internal
contract management capacity is positively associated with higher levels of transactional contract
features but is not significantly associated with the level of adaptive contract features. The bivariate
analysis also indicates that a higher level of internal contracting capabilities is significantly
associated with municipalities which spend more money on private contractors. The bivariate
association is congruent with earlier research which found support for an association between a
higher administrative capacity and higher contracting levels (Bhatti et al., 2009; Foged, 2016). A
higher level of use of external advice / consultants is indicated to be positively associated with
16
higher levels of both transactional and adaptive contract features. Low cost as contracting purpose
is not significantly associated with the level of neither transactional nor adaptive contract features.
A higher emphasis on low cost as contracting purpose is, however, significantly associated with
departments with less or no hierarchical integration of operational responsibilities. The finding
indicates that low cost is a more pronounced contracting purpose in municipalities which either
contract out all their services as well as in municipalities where the park and road department does
not have direct responsibilities as in-house provider. A higher emphasis on development as
contracting purpose is significantly associated with higher levels of adaptive contract features, but is
not significantly associated with the level of transactional contract features.
The next step in the analysis uses two hierarchical OLS regressions. The study‘s main
results are presented in Table 4. The first multivariate analysis explores the six predictors‘
importance for the level of transactional contract features (TCF) while the second analysis explores
the six predictors‘ importance for the level of adaptive contract features (ACF). Both multivariate
analyses are organised as hierarchical OLS regressions where predictors are introduced in blocks
into the regression (model A – C for TCF and model D – F for ACF).
Table 4. Hierarchical OLS regressions for level of formal transactional and adaptive contract features
Transactional contract features (TCF) adaptive contract features (ACF)
Predictor variables
Model A Model B Model C Model D Model E Model F
Unstandardized beta-coefficients (β) and standard errors
Transactional complexities (expenditures, LN)
1.020 (.347) ** 1.067 (.331) ** 1.137 (.342) ** .857 (.347) * .939 (.356) * .715 (.334) *
Hierarchical integration of operational resp. (0=low, 1=high)
÷ .946 (.530) † ÷ .771 (.479)
ns ÷ .599 (.510) ns ÷ 1.019 (.528)
† ÷ .918 (.509) † ÷ 1.300 (.493) *
Internal contracting capabilities (0-10)
– .278 (.144) † .297 (.146) * – .146 (.158)
ns .104 (.148) ns
Advice from external consultants (0-10)
– .311 (.094) ** .311 (.095) ** – .234 (.100) * .225 (.092) *
Contracting purpose: Low cost (0-10)
– – .134 (.124) ns – – ÷ .184 (.119)
ns
Contracting purpose: Development/learning (0-10)
– – ÷ .008 (.108) ns – – .329 (.105) **
Model summaries
n 57 57 57 57 57 57
Constant ÷ 2.541 ns
÷ 6.978 † ÷ 8.920 * ÷ 3.450
ns ÷ 6.782
† ÷ 4.058
ns
F-value 6.136 ** 7.444 ** 5.078 ** 5.236 ** 4.515 ** 5.566 **
VIF MAX 1.002 1.125 1.185 1.003 1.150 1.202
R2 / Adjusted R
2 .185 / .155 .364 / .315 .379 / .304 .162 / .131 .258 / .201 .400 / .328
Notes: Significance levels: † p < .1, * p < .05, ** p <.01, ns = non-significant.
17
The results indicate that five out of six predictors are important in some degree for
predicting the level of formalized contract framework. The importance furthermore differs between
prediction of respectively the levels of transactional and adaptive contract features.
Transactional complexity, measured by the absolute level of expenditure on private
contractors, is found to be important for both types of contract features in all models (A-F). The
analysis indicates that higher degrees of transactional complexity are associated with higher levels
of both transactional and adaptive contract features. Comparing the sizes of the beta-coefficients
indicates that importance of transactional complexity is slightly more pronounced for the level of
transactional contract features (β = 1.137 in model C) than the level of adaptive contract features (β
= .715) in model C). The predictor is measured by a logarithmic (natural scale) which implies that
the effect is more pronounced for absolute differences between relatively smaller economic
involvements (e.g. DKK 1 and 10 mill.) compared to differences between relatively larger
economic involvements (e.g. DKK 10 and 100 mill.).
Whether the department had a role as internal service provider (operational responsibilities)
is found to be important only for the level of adaptive contract features. The analysis indicates that
municipalities where the park and road department has no or a low degree of hierarchical
integration of operational responsibilities also have a higher level of adaptive contract features
implemented in their exchange relations with private contractors.
Likewise, departments which have a higher degree of hierarchical integration of operational
responsibilities, have significantly lower levels of adaptive contract features implemented in their
exchange relations with private contractors. The mean difference of 1.3 (measured on a scale from 0
to 10), between the two groups (low and high level of hierarchical integration) found in model F can
be interpreted as a relative large difference given the mean score of 4.9 for all municipalities.
Both internal and external expertise for drawing up contracts is found to be important for the
level of formal contract framework. Greater internal contracting capabilities are found to be
important for higher levels of transactional contract features but unimportant for differences in the
level of adaptive contract features. Involvement of external expertise is found to be important for
higher levels of both transactional and adaptive contract features. The finding indicates that Danish
municipalities have a degree of internal expertise for setting up transactional contract features, but
they mainly rely on involvement of external expertise for setting up adaptive contract features.
Differences in the municipalities‘ emphasis on low maintenance cost as purpose for
contracting out are found to be unimportant for differences in the level of both transactional and
18
adaptive features. Higher emphasis on development/learning as contracting purpose is, however,
found to be important for the level of adaptive contract features. The finding indicates that the level
of transactional contract features is independent from differences in the emphasis on the two
contracting purposes while the level of adaptive contract features varies with the emphasis on the
level of development/learning as contracting purpose. The finding indicates that the level of
emphasis on contracting purpose in some degree is reflected in formal contract design.
Discussions
Overall, the analysis supports the argument on the importance of transactional complexity for the
level of formalized contract design in implemented in public authorities‘ exchange relations with
their private contractors. The analysis supports the assumption that higher levels of contractual
complexity are associated with higher levels of both transactional and adaptive contract features.
The study‘s first hypothesis is supported by empirical findings.
The analysis partially supports the argument that hierarchical disaggregation will result in
more elaborate formal contract frameworks. The argument is only supported in the analysis of
adaptive contract features where it was found that separation, in terms of no direct operational
responsibilities, is associated with more elaborative adaptive contract features. The study‘s second
hypothesis is therefore not supported while the third hypothesis is supported by empirical findings.
The analysis supports arguments based on an organisational capability perspective on the
importance of specialized expertise for elaboration of formalized contract frameworks. The findings
indicate that it is important to differentiate between internal and external expertise. Both types of
expertise is found to be important for implementation of more elaborate transactional contract
features, however, only involvement of external expertise is found to be important for
implementation of more elaborate adaptive contract features. The findings indicate that some
Danish municipalities have developed a degree of internal capabilities for implementing a
conventional approach as part of their contracting capabilities while they rely on involvement of
external expertise for setting up more elaborate adaptive contract features. The study‘s fourth and
fifth hypotheses are therefore supported by empirical findings.
Finally, the analysis partially support the arguments based on the role of strategic intend for
the organization of exchange relations. The conventional purpose for contracting out, measured by
the importance of ensuring low maintenance cost was not found to be associated with the level of
formalized contract framework. However, greater emphasis on development/learning was found to
19
be associated with higher levels of collaborative contract features. The finding indicates that
municipalities implement some contract features with particular purposes in mind. Overall, the
study‘s sixth hypothesis is not supported while the seventh hypothesis finds empirical support.
A key contribution from the study is that ‗contracting out‘ is not just ‗contracting out‘. With
reference to the longstanding ‗make or buy‘ puzzle – also recently complemented by a ‗make and
buy‘ puzzle – in theories of economic organization as well as organisation of public service
delivery, the present study strongly suggests that the organization of the formal contractual features
of the ‗buy‘ option should be regarded as a puzzle in itself. Contracting out is not ‗just‘ contracting
out as a single discrete alternative within the overall organization of public service delivery. Formal
contract features of contracting out differ consistently – and by and large as indicated by theory –
across circumstances.
In addition, the implemented contract features go beyond conventional wisdom about
contracting out. Earlier research has ‗merely‘ scratched the surface of this puzzle by, for example,
describing the extent of variations (e.g. Walker and Davis, 1999, Lindholst, 2009), provided
conceptual frameworks for understanding variations (e.g. Greve and Ejersbo, 2006) or discussed the
comparative merits of different contract designs (e.g. Vincent-Jones, 2007).
The study supports the ramifications of the discriminatory alignment hypothesis implying
that municipalities align their contractual framework implemented in exchange relations with
private contractors in rational ways according to specific transactional, organizational and strategic
characteristics. Municipalities exhibit ‗rational‘ behaviours (at least they act in accordance with
theoretical expectations) in the choice of formal contract design.
A few studies have prompted concurrent sourcing or mixed service delivery as a possible
strategy for the organisation of public service delivery. The current study adds to this literature by
confirming the hypothesized assumptions on the exploitation of the comparative advantages of
respectively organizing maintenance operations through a combination of internal hierarchy and
external market-based relations.
Transactional characteristics has in most studies of contracting out been confined to a few
key dimensions (e.g. measurability and ease of specification) and the importance for contracting
levels across a range of public services. The current study emphasises that difference in
transactional characteristics within a particular setting too has importance for the organization of
contracting out in terms of the design of the formal contract. The current study found that increased
20
contracting challenges, in terms of the level of complexity, can be handled through formal contract
design as alternative to the make and buy option.
The study also highlights that (low) cost objectives are not the only relevant objectives to
observe when municipalities contract out. The conventional wisdom on the raision d‘entre of
contracting out as a mechanism for ensuring low cost as well as the need to align contract features
according to this objective will not be equally relevant for all instances of contracting out. This
study highlighted that contracting out also is designed and implemented with the aim to pursue
objectives related to development/learning.
Conclusions
Key findings
The study explores several characteristics which help explain why municipalities opt for different
contract designs. Overall, the study finds support for most of the suggested hypotheses. The
findings indicate that municipalities to a large extent acts in rational ways (or at least in
concordance with the theoretical reasoning) in their use of contracts in exchange relations with
private contractors. A more encompassing contract design is implemented when the involved
complexities of the transactions increases, contract design is to a certain extent aligned with
contracting purposes as well as contract designs are aligned with the advantages and disadvantages
of the chosen internal organisation (i.e. the level of hierarchical integration of internal provision).
Reliance on and the level of contract in exchange relations are furthermore dependent on the level
of internal expertise and involvement of external expertise.
Limitations
The study is based on a limited empirical basis. Firstly, the context of the study is limited to private
involvement in provisions of road and park maintenance services in Danish municipalities.
Secondly, the data for construction of response and predictor variables, except for one predictor, is
drawn from a single survey based on self-reported items. The limited number of cases in the final
analysis also limits the number of potential predictor variables.
Future research
The present study adheres to three main groups of explanatory characteristics: transactional,
organizational and strategic. All characteristics are found to have some importance for predicting
21
differences in key contractual features. However, research would benefit from exploring the
importance of further dimensions related to each explanatory characteristic. The range of potential
contract designs a public authority can adopt may depend on available possibilities within a
particular context in terms of, for example, institutional support, legal regulations, stage of market
development or sector specific design options. It would therefore be of interest to explore whether
the logics underlying design choices are similar or differ across, for example, sector and country
contexts. Research comparing for example hard and soft services would be able to explore the
importance for contract design of additional factors such as differences in political and citizen
interest. Such research may also assess the effect of institutional development or advancement of
different contracts within different service sectors.
A major research stream in studies on contracting out in the public sector is concerned with
overall outcomes and performance, in particular economic and quality effects. However, the present
study finds that differences in contract design is associated with variations in contracting purposes
different than cost concerns. Studies of economic effects may benefit from control for variations in
contracting purpose as well as contract design. In particular, contract design as part of the overall
organisation of the involvement of private contractors in public service delivery may to some
degree be a result of variations in the emphasis of other purposes than ensuring low costs. To put it
simple, not all contracts are designed with the sole purpose of minimizing costs. This finding should
be important for research on particular cost effects from contracting out as omission of purpose
would be a likely confounding variable blurring the understanding of when contracting out is used
as a cost minimizing strategy in public service delivery.
As an extension of the argument above it would be important to evaluate other performance
dimensions of contracting out aligned with local authorities‘ choice of strategic purpose, e.g. do
strategies and corresponding contract designs based on development and learning objectives result
in improved development and learning?
22
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26
Appendix
Diagnostics of principal component analysis
The ‗factorability‘ of the eight items, i.e. suitability of factor analysis, was initially assessed by
standard criteria. Statistics indicate that application of factor analysis on the eight survey items was
appropriate. The ratio between the total number of available cases for factor analysis (N = 64,
listwise) and the number of items (8) is reasonable for explorative factor analysis (a ratio > 5) but
not ideal (a ratio > 20). All items are correlated to several other items in some degree (>.4),
indicating that all items share some common variance with other items, and anti-image correlations
(diagonals) are all well above the recommended minimum of .500 (>= .746). Kaiser-Meyer-Olkin
of sampling adequacy is .833 (well above the recommend minimum value of .500) and Barlett‘s test
of sphericity is also significant (x2 (28) = 228.216, p < .001).
i Technical report is available upon request.
ii Concurrent sourcing is conceptually defined as sourcing of the same (i.e. similar) service to both internal and external
production (Parmaggio, 1997), but has in some studies been operationalized as a percentage of budgets spend on private
vendors within various service areas. It should be noted, that a formally defined service area contains various tasks that
requires different (i.e. dissimilar) skills and routines.
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