Serco was pushed into an embarrassing climbdown yesterday after the Government forced the outsourcer to retract a demand for cash rebates from its biggest suppliers.
Serco is one of the 19 outsourcers – the Government's biggest – that recently met with the Cabinet Office minister Francis Maude to discuss cost savings.
Following the meeting, where Serco agreed to support the Coalition's plans to save £800m from central government procurement for the year, the company's finance director, Andrew Jenner, wrote to 193 of Serco's suppliers asking for a 2.5 per cent cash rebate on work for 2010 in the form of a credit note. "Your response will no doubt indicate your commitment to our partnership but will also be something I will seriously consider in our working relationship as Serco continues to grow," Mr Jenner wrote in a letter leaked to the Sunday press.
The demands angered Mr Maude, who believed the savings would not be sought from suppliers, and who sought an explanation from Serco's chief executive, Chris Hyman.
The company subsequently withdrew its demand and apologised to suppliers. The group, which runs the London bike hire scheme, said it had reaffirmed that its "most recent offer of savings to the UK Government will not result in any of the Government's cost-saving programme being passed on to our suppliers".
The about-turn comes as the Government renegotiates contracts with key suppliers. Of the initial group of 19, 14, including the IT group Logica and the security services group G4S, have already signed memoranda of understanding with the Cabinet Office. Serco, whose activities cover education, health, justice and local authority services, remains in negotiations.
The Government welcomed Serco's reversal. "We hope we can now move forward quickly with the contract renegotiation process," the Cabinet Office said.
Quite apart from the negative publicity, the Serco saga prompts questions about claims that government cuts mean more business for outsourcers.
City analysts have been highlighting companies such as Serco as likely beneficiaries of the fiscal squeeze. Spending cuts, they say, mean greater demand for the sorts of efficiencies that outsourcers are geared up to provide.
Yet even before Serco's letter to suppliers, there were signs of trouble elsewhere, among the smaller companies in the sector. Back in September, the social housing specialist Connaught called in administrators after government cutbacks led to financial difficulties. Last week, the outsourcing and consulting firm Mouchel revealed a full-year loss and said the immediate outlook remained uncertain.
Andy Brown, an analyst at Panmure Gordon, said that while the opportunity to grow the work volumes still existed, the Government's stance on Serco's demand to suppliers raises questions about how the bigger outsourcers are going to deal with pricing pressures as contracts are renegotiated. Ordinarily, the supply chain would bear part of the pain, he said.
Mike Murphy, an analyst at Numis Securities, echoed this view in a note to clients, saying: "The withdrawal of the letter is welcome, not least by suppliers, but raises two important questions ... what is the level of discount Serco is likely to give to the UK Government? [and] ... How will it limit the impact of the discounts offered?"