Contestable markets for public services – Three sets of rules to get the fundamentals right

Contestable markets for public services – Three sets of rules to get the fundamentals right


Governments have been engaged in market design ever since they began to retreat from direct service delivery. A recent Productivity Commission report identified reform options to introduce greater user choice, competition or contestability into six areas of human services. While there is a lot of theory about how markets operate, the truth is that when it comes to publicly-funded services, we have been learning as we go. Through our work across jurisdictions and sectors, we have identified the key decisions that underpin market design. By tackling these systematically, public service leaders can be more confident in their designs and more optimistic about the outcomes.

The release of the Productivity Commission’s report, Introducing Competition and Informed User Choice into Human Services: Reforms to Human Services, continues a trend towards increased competition and contestability of government service provision by seeking to extend reforms to six further areas of human services[1]. At the centre of these and previous reforms is the rationale that through greater user choice, competition and contestability, it is possible to improve outcomes for citizens – especially, but not only, by stimulating innovation.[2]

The reality has been mixed. Hitting the trifecta of lower prices, better services and improved allocation of resources has proved elusive. An indicative assessment is provided in Figure 1.

Figure 1: Indicative assessment of market based reforms

Indicative assessment of market based reforms

As a result, many of the flagship reforms are in a state of flux. Unforeseen consequences and outcomes have necessitated changes in settings, initially minor and subsequently significant. For example, we have seen this play out with a number of changes to the VET Fee Help scheme before it was relaunched as VET Student Loans.

The challenge for policy makers is that markets are complex and difficult to predict. By their very nature markets are dynamic, bringing people together at different times and under different circumstances. They are also unpredictable as motivations and behaviours of actors (both providers and consumers) influence their interactions and outcomes. This necessitate a more iterative approach to policy setting.

Unintended outcomes from market-based arrangements for service delivery are unavoidable, but your likelihood of success can be maximised by focusing on the decisions that influence these interactions; in other words, getting the rules of the game right. In our experience three sets of decisions are key:

  1. Structure – Decisions that determine who can and should participate in the market
  2. Product – Decisions that determine what can be traded and how its quality is assured
  3. Exchange – Decisions that determine how transactions can take place

Key decisions shape NSW government introduction of contestability to Vocational Education and Training

1. Structure: Decisions that determine who can or should participate in the market

The first essential ingredient in a successful market is a set of consumers and providers that are willing to transact. Market structure is defined by the relationship between the number of consumers and providers. The structure of the market – by which we mean the overall size and composition – should be informed by the extent to which actors’ needs can be addressed, and the added value that each brings to the market. Key factors influencing the structure are outlined in Figure 2.

Figure 2: Drivers of providers and consumer added value that inform market structure

Drivers of providers and consumer added value that inform market structure

Consideration of the market structure, including, the number and type of actors able to participate in the market, can have a strong bearing on public benefit outcomes achieved. Markets’ need not cover 100% of service delivery – in fact separating out segments of consumers or providers that are not well placed or prepared for a market can lead to better outcomes. For example, in looking at implications of competition reform for regional and remote Australia based on experiences with NDIS and VET reforms as well as other government programs, we found it may be better to serve the needs of rural and remote communities through a different set of policies than communities in metropolitan and regional areas.

2. Product: Decisions that determine what can be traded and its quality assured

Effective market design starts with a strong understanding of the product or service to be traded, such as:

  • The degree to which demand varies with changes to consumer income and purchase price. An example of this exists in higher education, where higher prices can lead to increased demand as price is taken as a signal of quality (known as a Veblan good).
  • The extent to which others can be excluded from using the good or service, and the extent to which consumers rival with one another to consume the good or service. Rules that govern a public good such as street lighting would be quite different to those related to trade in pharmaceuticals.
  • The extent to which consumers can ascertain the value of the good or service prior to consumption. In healthcare it is sometimes difficult to assess the value before (or even after) treatment, whereas the value of electricity is clear – it is either on or off.
  • The physical characteristics of the good. Factors such as durability, variability in product quality or diversity of product have implications for the rules that may be required.
  • The intended use of the good. In VET it is clear that there are segments that place a high value on the education they experience while others simply require recognition of skills they already have.

The challenge for policy makers is to ensure that standards, monitoring and enforcement are rigorous enough to ensure the needs of consumers are met, but flexible enough to enable innovation and responsiveness as needs change. One approach to addressing this challenge is to engage consumers directly in the process. Faced with variable quality in VET provision, the Victorian Government expanded the use of student feedback in quality assurance. Feedback enabled monitoring and enforcement activity to be better targeted, leading to improved detection of training quality issues.

3. Exchange: Decisions that determine how transactions can take place

The final set of decisions is about bringing consumers and providers together to transact. These decisions are influenced by the type of market to be established, and the way in which the forces of demand and supply combine to determine market outcomes. Figure 2 provides three illustrations of common types of markets.

Figure 3: Market types

Market mechanism: The nature of the market will have a bearing on what the optimal mechanism may be.

Within each type of market, rules guide provider behaviour in response to consumer needs. In private markets, price signals inform providers’ decisions to produce what people want. However, markets for public services often operate under the constraint of budget limitations. This means there must be mechanisms to inform actors about what it is that government can afford or will support (e.g. funded course lists in vocational education and training).

Regardless of the approach to achieve sustainable markets for public services, exchange rules must equip consumers and providers to:

a) make smart choices; and

b) transact effectively and efficiently.

Funding, information and other incentives or penalties provide useful levers for Government in shaping the dynamics of exchange.

Stability requires careful consideration of each set of rules and how they combine

The creation of a well-functioning market is challenging. Get it right and the benefits in terms of access, innovation and efficiency can be significant. Get it wrong and instability, inappropriate behaviour and waste are likely. Investing the time early to understand how decisions on product, structure and exchange can combine to influence market outcomes is the first step to ensuring strong and well-functioning markets for public services. When combined with proper modelling and road-testing, strong monitoring to ensure the market is adapting and thriving and targeted refinements as the market evolves, policy makers will be well positioned to ensure desired outcomes for governments, providers and consumers are achieved.

Get in touch for more information on how Nous can support your market design challenge.

[1] Areas of focus include: end-of-life care services; social housing; family and community services; services in remote Indigenous communities; public hospitals for elective care following a referral from their general practitioner and public dental services.

[2] Harper review, P31