LONDON (Reuters) - The unexpected departure of the boss of Capita CPI.L highlights the challenges facing Britain's biggest outsourcing companies as the government tightens the screw on businesses that provide vital public services.

A Serco flag is seen flying alongside a Union flag outside Doncaster Prison in northern England in this December 13, 2011 file photograph. REUTERS/Darren Staples/Files

Capita Chief Executive Andy Parker announced his resignation on Thursday after the business support services group reported a bigger than expected drop in 2016 profit, capping a 12-month period in which its share price has plunged by 50 percent.

Parker's decision to step down later this year comes after rival Mitie MTO.L issued three profit warnings in four months and appointed a new CEO and CFO, having lost a quarter of its market value over the last year.

Profitability has come under increasing scrutiny in recent years as rising employment costs and cuts to local council spending have placed operating margins under intense pressure, leaving the likes of Capita, Serco SRP.L and G4S GFS.L with little room to make mistakes or absorb any drop in demand.

Serco CEO Rupert Soames, stung by the company’s loss of a fifth of its market value in a single day last month after it delivered an uninspiring outlook for the next two years, says that outsourcers now have to be more cautious about the work they take on.

“(Some years ago) the ambition of companies collided with a government that is getting ... very, very, very tough on the terms and conditions,” he said. “The result has been, for quite a few companies, including mine, a very ugly car crash.”

“I think the pendulum is swinging back and companies are now becoming more cautious about what they bid for.”

The tightening of government purse strings has already proved costly for Capita, which earns nearly all its revenue in the UK, with roughly half coming from the public sector.

DRIVING A HARD BARGAIN

Its exposure was highlighted by a contract to create a single system to provide training for multiple government departments and agencies.

The 250 million pound ($306 million) contract was awarded in 2012 but was not renewed in 2015, instead being split into four components. Barclays estimates that the 60 million pounds in revenue from the contract in 2015 dropped to 40 million pounds last year and will virtually disappear this year.

IT and telecoms giant BT BT.L has also been hit, saying in January that it expects underlying fourth-quarter core earnings at its Business and Public Sector division to fall by a double-digit percentage year on year.

A source at the company said the government was driving a hard bargain, drawing up standard contracts that no longer provided the bigger margins that could be earned from long-term bespoke contracts.

“Where you have a business where those types of contracts come to an end, that can be quite a challenging transition to make, and that’s what we are working through,” the source said.

Asked if BT would now avoid low-margin work, the source replied: “Correct.”

Britain began outsourcing public services in the late 1980s under Margaret Thatcher’s government and enjoyed a boom period during Tony Blair’s time as Prime Minister at the turn of the century, with companies winning long-term contracts worth hundreds of million of pounds.

Private companies now handle everything from parking permits to immigration control and maintenance of nuclear warheads. But as the sector has matured and technology developed, clients have moved to shorter, standard contracts offering lower margins.

Complexity has also been reduced with the advance of automation and the standardisation of many IT services, while constraints on government budgets and Britain’s vote to leave the European Union have added to the pressure.

DIFFICULT RELATIONSHIP

John Keppel of ISG, which tracks the global outsourcing market, said that shorter-term contracts effectively force companies to submit more competitive pricing bids because the increased frequency of tenders require that they take into account the latest advances in technology.

“There’s far more pace in the change in technology, so no one is willing to jump into a relationship that lasts longer than the immediate horizon. So now it takes six months to agree the terms to something that is going to be over in 18.”

A spokeswoman for the Cabinet Office, which helps to coordinate government departments, said it was committed to ensuring support for small businesses and growth and innovation through its public procurement.

Keppel said there are enough smaller firms to pick up the work, but the big players are having to rethink their approach after the government sought not only to cut costs but also to keep greater control of services after the outsourcing sector was the subject of a string of scandals in 2012 and 2013.

G4S, which operates in more than 100 countries and employs more than 600,000 people, has been heavily criticised for mishandling sensitive work, including its failure to provide enough security guards for the 2012 London Olympics.

Together with Serco, G4S was also investigated by the Serious Fraud Office after it charged the government for putting monitoring tags on criminals who were either dead or in prison.

G4S says it has “materially strengthened controls over the approval of major contracts” since then and has increased sales outside of Britain.

Serco boss Soames said that others could do the same, with the United States and Australia proving attractive.

“We’re not deliberately going to try to tilt our revenues away from any jurisdiction,” he said. “But what we do believe is in being present in several jurisdiction so that when the political winds change, we always have a safe harbour.”