Lies, Damned Lies And Children's Homes Profits

We really are being lied to about this

It has now become one of those generally agreed things among the haute bourgeois who rule us that the profits made by the private sector providers of children’s homes are high, too high. This is also bullshit and we’re being lied to. No, really, this is wrong:

Then there is the worrying state of children’s homes. They used to be run largely by councils and charities, but these bodies have been leaving the sector and private equity firms have filled the gap. Prices, again, have been rocketing. According to an investigation by the House Magazine, the average annual cost of a place in a children’s home is £281,000, more than five times the cost of a prison place. The CMA has calculated the average profit margin in the sector to be 19.4 per cent — “materially higher than we would expect”.

Firms can make fat profits because the number of children needing placement has risen, the number of foster places available has gone down, and when a child urgently needs to be put in a home, councils don’t have time to shop around. It’s a seller’s market, in other words, and firms take advantage of that. The CMA is also worried about levels of debt: the business model for private equity companies is to use little of their own capital and borrow heavily. Highly leveraged businesses are more likely to go under in tough times. If the business in question is a home for children, that matters a lot.

That’s from Emma Duncan in a major, full sized, column for The Times.

The Competition and Markets Authority also believes it, propagates it even:

Given the vital importance of good placement matches for successful outcomes for children, and particularly the negative impact of repeated placement breakdown, these outcomes should not be accepted. It is a fundamental failure in the way the market is currently performing.

Second, the prices and profits of the largest providers in the sector are materially higher than we would expect them to be if this market were working well. The evidence from our core data set, covering 15 large providers, shows that these providers have been earning significant profits over a sustained period. For the children’s homes providers in our data set we have seen steady operating profit margins averaging 22.6% from 2016 to 2020, with average prices increasing from £2,977 to £3,830 per week over the period, an average annual increase of 3.5%, after accounting for inflation.

It is, as I say, bullshit.

Now, there’s always a certain problem with insisting that the whole world’s mad except for thee and me - and I’m not so sure about thee neither. It’s the sort of thing you’d expect to hear from an ageing West Country boy who’s been drinking his scrumpy from a pewter tankard for too long*.

The thing is I am in fact right here.

I’ve touched on this here before:

Except that 23% number is not correct. In fact it’s not just wrong it has been deliberately constructed to mislead us.

Please note a couple of things here. No, I’m not happy that kiddie homes cost so much. Nor am I insisting that they should be private market provided, public, charitable, not for profit or anything else. My point here is not about how children’s homes should be. It is about how we are being manipulated by politically constructed numbers.

The 23% is the EBITDA margin, the gross profit close enough. To get from this number to net profit - the bit the capitalists get to keep and surf down a la Scrooge McDuck - we have to include, or even subtract, the interest, tax, depreciation and amortisation.

What’s a pretty big cost of running a home? The interest you pay on the mortgage, the depreciation of the building - new roof every 30 years, that sort of thing - and the writing down, the amortisation, of the original purchase price. What’s not included in EBITDA? All those costs of having a children’s home in which you can run a children’s home.

There’s also been an extension of the idea to another sector:

What is being done here is, umm, most odd as an accounting method. For the analysis looks at “profits” as being EBITDA margin. Earnings before interest, taxation, depreciation and amortisation. This is a measure that has its uses, sure it does. But it’s useful as a measure of the operating cashflow of an organisation before it starts to service its capital costs - that interest, amortisation and so on. But using it as a measure of “profits” is wrong, conceptually wrong.

But by doing this it is possible to claim two wildly contradictory things. Both that vast profits are being made and also that the debt piles are so high as to call into question the viability of the business model. Those with even a vague grasp of business will note that vast profits mean debt burdens are not a problem, or equally, that vast debt burdens mean that not much profit is being made. It’s only possible to claim the wrong pair of that quartet - high profits and also dangerous debt - by entirely misusing EBITDA as a measure. Firmly grasping the wrong end of that ordure encrusted stick that is. Then stirring.

Now, true, this “analysis” was done by Trinava Consulting, which is a different company from Revolution Consulting which did the care homes “work”.

We are being lied to, in a big way. Operating margin, operating profits - the CMA measure - and EBITDA aren’t quite exactly the same but they’re very closely akin. They’re measures of the cashflow the company - organisation - has to address the capital costs of running the company. Interest on loans, the costs of repaying loans, the repair and maintenance of capital assets and so on.

Net profit is the amount the capitalist bastards run away with at the end.

Whether the capitalist bastards are running away with too much or not depends upon the net profit level. Whether the line of business is fiscally secure or not depends upon that operating or EBITDA number - can they afford the debt loads they’re carrying?

What is being done here is to reverse those two numbers. EBITDA/operating is being used as the measure of how much the bastards get, net profit as the measure of whether they can afford the capital costs.

We’re being lied to.

This is being done by the CMA, Revolution Consulting, the LGA, Trivada Consulting and the end result is that the sorts of political movers and shakers who determine policy now actually believe this dreck.

It is also all deliberate.

Public policy is now being based upon the idea that children’s homes, child care - and no doubt soon all sorts of other exciting areas of life - are dominated by people in that impossible quadrant, both wildly profitable and also financially fragile because of their debt loads.

At which point we’ve really got to ask ourselves an important question. What the fuck do we do about this?

Firing squads obviously won’t work. Asking politics and journalism to become numerate is equally an impossibility. So, what, actually, do we do?

*Scrumpy, that is proper cider, is fairly acidic. This means that it will leach the lead out of pewter and thereby give long term drinkers lead poisoning. Over and above any problems that might come from decades of scrumpy consumption. However, folk around my way know this. You can always tell a cider house by the fact that the tankards hanging over the bar are made of pottery, ceramics, not pewter. Those of us from Devon and Somerset may well be different, in a very good way, but we’re not stupid. Well, not unless we weren’t told about the pewter at the local start of drinking scrumpy age of about 10.