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Editor's blog Thursday 25 February 2010: On hybrid organisations

I spent last night somewhere heavily armed, discussing hybrids.

Not, it wasn’t a high-security biochemical research facility. Nor was I discussing the Toyota Prius with some edgy yoot’ somewhere urban and grim.

It wasd the Foundation Trust Network’s lecture, held at the Worshipful Company of Artillery. Hence all the guns (in the heart of the City of London, on the day of the Queen's visit).

And the speaker was author, journalist and respected commentator John Kay, discussing Managing the public-private boundary. (Kay’s new book – Obliquity – why our goals are best achieved indirectly – will be available from Profile in March 2010).

Hybrid organisations: one size does not fit all in governance, capital structures and regulatory arrangements
Kay's definition of hybrids covers organisations that delivers services - thus requiring business management skills - but whose functions are broad public interest concerns and whose revenues not normally earned in competitive markets.

He also stated that  that “the way we deal with hybrids is perhaps the fundamental public policy issue of our time”.

His examples of such hybrid organisations include universities, Network Rail, the electricity and gas infrastructure networks, Channel 4, housing associations, contracted-contracted-out public sector providers and Transport For London. Each of these, Kay said, invents from scratch different governance, capital structures and regulatory arrangements - failing to learn from others' triumphs or tragedies.

Quality, management, governance and regulation
The governance of hybrid organisations, Kay said, is not merely central to issues of output quality. Output quality depends on management; which depends on governance; which depends on the regulatory framework.

We have, Kay added, come some way in our thinking about governance, finance and management issues of hybrid organisations, but still usually think about state activities through the prism of processes, rather than fcusing our attention on the more important outcomes.

Defining hybrids through questions, Kay proposed that we could ask:
1. what is the governance structure, who appoints management and to whom do management report?
2. what is financial structure, and how is equity provided (implicitly or explicitly)?
3. what if any external regulation (accountability other than through governance structure) exists?

He added that we would find different answers to almost every question in his suggested list above.

He outlined six main potential governance structures:
1. government appoints the non-executive directors (NED) board, which appoints the executive board
2. government appoints both
3. the board is self-perpetuating and appoints exec management (this works for UK PLCs and has just rhetorical accountability to shareholders)
4. democratic election for management
5. democratic appointment of the NED board, which then appoints the executive board
6. Multiple constituencies appoint the NED board which appoints executive management

Kay suggested that this last option (6) is the most attractive option in many ways, suggesting that the best-run hybrid organisations he knows – the top US universities – use this approach.

He also outlined various financial structures
1. corporate structure with state-provided equity
2. regulated corporate structure with privately provided equity
3. orphan equity from historic surpluses (Welsh Water)
4. some equity from ancillary activities (BBC)
5. debt, some of which has quasi-equity characteristics (PFI SPVs)
6. no equity and annual negotiation over funds – variance between outcomes and budgets is why businesses require equity (FTs)

Kay suggested that of equal importance is the chosen form of external regulation
1. regulation of overall business performance
2. regulation limited to specific outcomes or measures
3. regulation of outcomes may (or may not) be combined with regulation of financial performance
4. in many cases, most regulatory activity is assumed to be performed by a NED board – typically the best way, as it is sympathetic and on-side in performance management, but easily goes native and becomes an over-sympathetic cheerleader – so need internal and external regulatory activity

Kay’s preference is for boards appointed by multiple constituencies, with external regulation powerful enough to keep internal regulation by the board up to the mark. The area of the most interesting issues and where the most thoughtful work is needed to draw lessons and to create a hybrid sector robust enough to manage very large areas of public sector going forward is the financial sector. Kay suggested that the financial sector tends to be motivated by deriving large fees for already-invented products, rather than modest fees for uninvited but required products. The requirement for the hybrid sector is the other way round.

The objectives of hybrid institutions include:
- to distinguish the control and availability mechanisms for semi-commercial organisations from those associated with process and propriety
- to give professional management responsibility and autonomy in day-to-day decisions, removing those decisions from second-guessing (which he dubbed “meddling without responsibility”) and direct political accountability
- to combine this with meaningful accountability for both output quality and financial performance over a medium-term period
- to affirm that the purpose of limited financial autonomy is to reinforce managerial autonomy not to support ‘funny financing’ such as PFI (attractively bringing in private sector project management) or financial services
- to prevent capture of the organisational structure by particular interest groups, which tend to be employee interest groups with a large veto over management activities

Outcomes, not processes
Successful hybrid organisations must, Kay concluded, find a challenging balance between offering short-term autonomy (at every level, from chief executive to employee) with medium-term accountability for performance. In almost all public sector activity, delivery relates to overall organisational performance, and can rarely be reduced to a simple list of metrics.

The complex objectives we want from hybrids require the development of difficult and complex judgments of the quality of outcomes in economic terms for the public sector, as opposed to our previous measures of the quality and propriety of processes.