Essential Guide: Competitive Neutrality for NSW Councils

What is competitive neutrality and why is it important?

Competitive neutrality is about creating a level playing field between in-house and external tenderers in a tender process. It aims to eliminate resource allocation distortions which can arise when public entities participate in significant business activities[1]. Competitive neutrality principles are therefore relevant when councils are undertaking a tender process and also wish to submit an in-house bid for the service. Applying competitive neutrality principles can encourage participation in a tender process. More competition generally increases the prospect of a council achieving a good value for money outcome and reduces the likelihood of a challenge to the outcome of a tender process. It is also appropriate for councils to consider the principles of competitive neutrality when they use internal cost data as a tender evaluation benchmark to ensure they are comparing like with like.

The Competition Principles Agreement underpins the National Competition Principles. Local councils are bound by this Agreement even though they are not a party to that document[2]. The NSW Government has published three key guidance documents on competitive neutrality which are relevant to local councils:

1. the Policy Statement on the Application of Competitive Neutrality: Policy and Guidelines PaperJanuary 2002 (the Policy Statement);
2. Competitive Tendering Guidelines January 1997 (the Guidelines); and
3. Pricing & Costing for Council Businesses: A Guide to Competitive NeutralityJuly 1997 (the Neutrality Guide).

The Policy Statement sets out the broad requirements of competitive neutrality as they apply to all government businesses at the State and Local level. The Guidelines are intended to assist local councils to decide when to engage in competitive tendering and outline the processes involved generally[3]. The Neutrality Guide is designed to assist Local Councils to apply the requirements contained in the Policy Statement to their business activities.[4]

When should a council consider participating in a competitive tender process?

Councils often participate in a competitive tender process to assist them to decide whether to transition from a model of public service provision to private service provision under contract. The Guidelines list a number of procurement areas in which councils regularly participate in competitive tendering. This includes waste and recycling collection, maintenance of council properties, roadworks and management of public facilities such as swimming pools, caravan parks and libraries. However, this list is not exhaustive. Depending on the in-house capabilities of the council, there may be other services for which it is appropriate that a council participate in a competitive tender process.

When is a council required to maintain competitive neutrality?

Under the Policy Statement, councils have an obligation to maintain competitive neutrality during a tender process for a business activity of a council in which the council also intends to submit an in-house bid.[5]

When determining whether an activity is a business activity the Neutrality Guide requires a council to consider the nature of the activity, whether it is, or is likely to be, subject to competition from other providers and its importance to the council’s customers. Matters which indicate that an activity is not a business activity include where it is a small-scale activity included within a larger function of a council, or where it forms part of a community service function of the council. The Policy Statement identifies activities such as water supply, sewerage services, abattoirs and gas production and reticulation as business activities.

The competitive neutrality obligations which apply to a council will also depend on the income generated (or proposed to be generated) from the business activity which is being tendered for. The Neutrality Guide imposes different obligations depending on whether or not the annual sales turnover/annual gross operating income of the business activity is over or under $2 million. The competitive neutrality obligations imposed on a procurement for a Category 1 business activity ($2 million or over) are greater than those which apply for Category 2 business procurement (under $2 million). For Category 1 business activities it is expected that the benefits of applying competitive neutrality will outweigh the costs of doing so[6]. For the procurement of a Category 2 business activity a council must still compete on the basis that they do not use their public sector position to gain an unfair advantage in the tender process, but they have flexibility in how they apply the Neutrality Guide. For example, councils have discretion to determine the extent to which the activity is separated from the other operations of the council, and need only adopt a full cost attribution where practicable.[7] For Category 2 business activities, applying the principles of competitive neutrality on this flexible basis may still be helpful to encourage competition and reduce the likelihood of a challenge to a council’s decision to award the contract to any particular tenderer.

Implementation of competitive neutrality

The first step is to consider when your council needs a new service, or an existing contract is coming to an end, is whether the Council may wish to participate in the tender process. It is important to identify this early in the process so that the Council can ensure that the in-house business unit is separated from the team running the tender process and that the relevant systems (such as the complaints handling system) are put in place prior to the release of the tender documents

Where a council is participating in a tender process then steps a council can take to implement the competitive neutrality principles include:

1. Separating the operations of the business activity from the general operations of the council. This does not mean that the council needs to establish a separate legal entity for the business, but the parameters of the business within the council need to be able to be identified. This means there needs to be an accounting and reporting framework for the business which is separate to the other activities of council and, for probity reasons, the council must be able to restrict access to tender material and documents by members of the business unit.Separating the business activity from the general operations of the council will also assist councils to identify and protect access to information under the Government Information (Public Access) Act 2009 (GIPA Act) which could prejudice the competitiveness of the business unit. Section 14 item 4 of the GIPA Act provides that there is a public interest consideration against disclosure of information if disclosure could reasonably be expected to undermine competitive neutrality in connection with any functions of an agency in respect of which it competes with any person, or otherwise places an agency at a competitive advantage or disadvantage in any market.
2. Establishing a complaints handling system for competitive neutrality issues. Your council’s existing complaints management process may already be adequate for this purpose.
3. Adopting a full cost attributionto the council’s provision of the service. For example, adjusting the price of the good or service in question to make allowance for taxes, the cost of capital, and any other material costs not borne by a government business purely as a result of its public ownership status for the purpose of tender evaluation. This principle is also relevant where councils use internal costing information as a benchmark to inform tender evaluation.
4. Where the council decides that the social benefit of subsidising a good or service outweighs passing on full costs to consumers, making those subsidies an explicit transaction; and
5. Complying with the same regulatory requirements as the private sector (which in most cases local councils are already required to do).
6. Identifying the possibility that an in-house business unit will tender for the services in the request for tender documentation and will be taken to be a complying tender (notwithstanding that the council will not be able to comply with the contract and conflict of interest declaration requirements etc).

Additional detail on some of these steps is set out in the Neutrality Guide. For step by step guidance to assist with your council’s next procurement, please contact Alice Menyhart and the Local Government & Planning team.