The good and bad in-house entity
There has been a great deal of public discussion about in-house entities in the form of a limited liability company and the negative effects of procurements from them. Such procurements involve risks, but on the other hand, they may also be useful, and not all in-house entities cause market disruptions. Procurement regulations restrict in-house procurements, which the companies must take into account in their business activities.
Public-sector entities can purchase the products and services they need on the market or produce them in their own organisation or in an in-house entity owned by them (in-house actor or in-house company).
In our recent audit, we examined the key benefits, risks and efficiency of procurements from state-owned in-house entities and whether the procurements made have complied with the procurement regulations.
A key benefit is avoiding competitive tendering
If the conditions set out in the in-house exception to the procurement regulations are met, procurements do not have to be tendered. This saves the resources of contracting authorities. Such procurements also make it possible to utilise the expertise and knowledge that in-house entities have accumulated of the central government. Overall, the central government authorities have quite positive experiences of in-house procurements.
For an in-house entity, a key risk is dependence on one customer. An in-house entity would face difficulties if the central government’s purchases were reduced. This risk has already been realised in several companies due to the central government’s savings.
State-owned in-house entities do not usually have significant negative market effects
In-house entities have been addressed in Prime Minister Orpo’s Government Programme. According to the Government Programme, it is a problem that in-house entities operate in the market and compete with companies that have entrepreneurial risk. The public sector’s possibilities of using in-house entities to provide services for which there is a functioning market should be limited.
In-house entities can have both positive and negative effects on the functioning of the market. Their operations can limit competition in the market as described in the Government Programme and make it more difficult for private companies to conduct their business. On the other hand, the operations of in-house entities can compensate for market deficiencies.
State-owned in-house entities do not usually have the same kind of negative market effects as the in-house entities of municipalities and wellbeing services counties. Either there are no direct competitors in the market for their services, or their market effects are limited.
Organising a company’s activities as an in-house entity can also be justified for reasons of security of supply. Leijona Catering Oy and Suomen Erillisverkot Oy have a strategic partnership agreement with the Finnish Defence Forces, and under this agreement, they provide the agreed services to the Defence Forces in all states of readiness.
State-owned in-house entities often do not have direct competitors. In the absence of market competition, it is important to encourage these entities to operate efficiently. Traditional key financial indicators (such as operating profit and operating margin) are also suitable for assessing the operations of a special assignment company. It is also possible to measure their efficiency utilising company-specifically tailored indicators that are regularly monitored.
External sales restrictions prevent in-house entities from expanding their business
Procurements from in-house entities are based on the exception concerning in-house entities in the Public Procurement Act (1397/2016) and the Special Sectors Procurement Act (1398/2016). The provisions on the exception include the definition of an in-house entity, rules on the exercise of ownership control in the company, and limits on an in-house entity’s permitted sales to customers other than the contracting entities owning it (permitted external sales). A special characteristic of in-house companies is that the procurement regulations set rather strict framework for their operations.
In principle, in-house entities can expand their business and, at the same time, reduce their dependence on their state owner by increasing their external sales. However, this is hindered by the strict limits the procurement regulations set for external sales. Exceeding these limits may lead to the loss of the in-house entity status.
The state has in-house entities that have arranged their sales to other customers than the company’s owners through a subsidiary. A subsidiary operating in the market in such a group of companies is not an in-house entity, and its sales are not subject to the external sales restrictions set by the procurement regulations. However, it is not certain whether it is allowed to make use of such a group structure. There is no case law on the matter, which makes the legal situation unclear in this respect.
Procurement regulations restrict the operations of in-house entities with several different owners
An in-house entity may have many owners, in which case the holdings can be small. In such a situation, it is not necessarily clear whether the requirement concerning the exercise of ownership control referred to in the Public Procurement Act is met. Companies often aim to strengthen the in-house entity relationship between the company and its owners, as referred to in the procurement regulations, through provisions in the shareholder agreement or the Articles of Association by creating possibilities for the shareholders to exercise control over the company.
A large number of owners also sets restrictions for carrying out procurements between the different actors. In such a situation, it is not permitted for the in-house entity to carry out procurements from its owners (reverse in-house procurement). Nor are in-house procurements between different state-owned in-house entities (procurements from in-house sisters) permitted.
At the time of writing this report, a reform of the Public Procurement Act is under way to set contracting entities a requirement for a 10% minimum holding in their jointly owned in-house entity. If the minimum ownership requirement is implemented as proposed, it is evident that the holdings in in-house entities will need to be significantly reorganised.