Section 3: Cost Structure of The Market
3.1: Previous Research
"The ELC sector in Scotland operates as a mixed economy model with a mixture of public, private and third sector providers. Most of these providers offer the funded entitlement.
However, for providers in the private and third sectors the Financial Review of Early Learning and Childcare in Scotland highlighted that the majority of their income comes from the fees that they charge to parents and carers for non- funded hours."
26. The Financial Review of Early Learning and Childcare in Scotland: The Current Landscape, published in September 2016, set out more context on the structure of the childcare market in Scotland and the sources of income for private and third sector providers. As part of the Financial Review of ELC, the Scottish Government commissioned Ipsos MORI to produce Costs of Early Learning and Childcare Provision in Partner Provider Settings.
27. The analysis highlighted that, in 2016, around 23% of the income that funded providers received was from funded hours. The report found that this share was considerably higher for funded providers located in remote areas.
28. The majority of funded provider income (around 77%), in 2016, was from fees paid directly by parents and carers. This could cover fees for non-eligible children (for example, those aged 0-2) or for additional hours that parents of eligible children required (for example, non-funded hours or 'wrap-around' hours).
29. The share of income accounted for by the funded entitlement in funded providers is expected to increase with the roll-out of 1140 hours as settings allocate more of their capacity towards delivering the funded hours.
30. The report highlighted that the average (mean) reported rate paid to providers in 2016 by local authorities for delivery of the funded hours (for 3-5 year-olds) was £3.59 per hour. This compared to an overall estimated average (mean) cost to providers of providing one hour of ELC to 0-5 year-olds of £3.70. However, the report also highlighted that:
"the cost estimates are an average across 0-5 year-olds. Because of the higher costs associated with younger children (for example, due to higher adult-child ratios), the average unit cost of providing ELC to 0-2 year-olds will be higher than £3.70, and for 3-5 year-olds will be lower."
31. Analysis produced using data from the Financial Review highlighted that, in 2016, the funding rate paid by local authorities to around 40% of funded providers in the private and third sectors did not cover their costs for delivering the funded hours.
32. To determine sustainable rates, it is important to have a shared understanding of the cost of delivering the funded entitlement. This will support local authorities to establish an affordable and sustainable rate for delivery of funded hours across private and third sector providers, including childminders. While actual costs need to be explored locally, previous research on private and third sector providers has demonstrated that the cost of provision is similar across these settings.
33. Table 1 shows the breakdown that the Ipsos MORI report found in the 'average' provider cost structure.
Table 1: Cost breakdown from Ipsos MORI report
|Cost (across 0-5 year olds)||Percentage|
|Rent / Mortgage||7%|
|Play and learning equipment||3%|
34. Whilst the Ipsos MORI report captured a range of detailed cost information, it did not include information regarding the return on investment (profit) within settings.
35. A key feature of a sustainable rate is that it needs to allow for investment in the setting - staff, resources and physical environment - to ensure continuity of service. This occurs through profit in a private sector setting or surplus in a third sector organisation.
36. Data produced by Ibis World, which covers the Pre-Primary Education sector at the UK level, is shown in Table 2.
Table 2: Costs breakdown from IbisWorld Industry Report
|Industry Costs (2017-2018)||Percentage|
37. The research confirmed the primary cost of service provision is related to staff (at between 70-73% of cost) despite the two pieces of research focusing on different time periods (Ipsos MORI in 2016 and IbisWorld in 2017-18) and geographical markets (Ipsos MORI Scotland only and IbisWorld is UK-wide).
3.2: Specific Considerations
38. There are other considerations in setting a sustainable rate which have not been covered in previous research or have changed since this research was carried out. It is important that these are recognised when setting sustainable rates in local areas (See Table 3).
Table 3: Considerations specific to the Scottish ELC marketplace or policy
|Inflation||Annual inflationary uplifts were included in the multi-year funding agreement between the Scottish Government and COSLA to support delivery of the expansion. Local authorities should consider how to account for the effects of inflation while reviewing and setting rates. This includes being transparent about the time period in which inflationary uplifts will be reflected in any changes to the rate.|
|Real Living Wage Increase||Settings delivering the funded entitlement will, in accordance with the supporting guidance on Transition Options for Contracting, pay the real Living Wage to all childcare workers delivering the funded entitlement from August 2020. Note: For childminders, this is only relevant where workers are regularly employed to provide direct care to children. Where possible, the process for determining the sustainable rate should identify the estimated element of the rate which reflects payment of the real Living Wage commitment.|
|Business Rates||Since the publication of the Ipsos MORI analysis, 100% business rate relief for premises wholly or mainly used as day nurseries was introduced from April 2018 (for a minimum of three years).|
|Food||As set out in the Operating Guidance, funding to deliver the free meal commitment from 2020 will be additional to the sustainable rate for funded providers. Local authorities must ensure that they are transparent as to the funding being provided to private and third sector providers for the delivery of the free meal commitment. Providers will also receive additional payments (i.e. additional to the sustainable rate) for delivery of a healthy snack and milk. In order to minimise the administrative burden on funded providers, local authorities may wish to include all these elements in one payment, however, there should be transparency for providers regarding the separate elements of funding being provided.|
|Local Market Structure||The makeup of the local market may require additional consideration in the sustainable rate setting process. This is especially important in areas where the market is fragile, such as rural or remote areas. Ensuring adequate representation of different types and sizes of providers will lead to a rate being set that is more reflective of the local market as a whole.|
|Transport and Clothing Costs||Transport and clothing are not statutory requirements and, therefore, have not been included as cost elements. However, dependent on local delivery plans and circumstances, local authorities may take a different approach to these costs.|
39. In addition to these specific considerations, a full breakdown of standard costs and cost elements can be found in Annex A of this paper. This information should be used to inform local sustainable rate setting.