Carillion shows dysfunctional market is in dire need of reform

Carillion shows dysfunctional market is in dire need of reform

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Written by: Martin Davies
Published: January 2018, The Times Online www.thetimes.co.uk

The knives rightly are out for Carillion’s senior management, but government and the construction industry must also urgently address the deep-seated problems of waste and inefficiency that made such a corporate catastrophe almost inevitable.

Action has been needed for years, but there have just been excuses for delay. Most damningly, since 2011 the government construction strategy has included a new procurement system that might have prevented the present crisis. One option would have forced companies such as Carillion to work as partners with their specialist contractors, preventing them from improving their financial position by withholding or delaying payments.

If good is to come from Carillion’s collapse, it will be the reform of this totally dysfunctional market. The clearest evidence of the need for change comes from some of Carillion’s strategies, including sub-economic tendering, off-loading risk to smaller subcontractors and, above all, failing to pay its supply chain on fair terms.

This culture of risk-dumping and confrontation may shock those in better-ordered industries, but this has been the norm for most main contractors for the past 50 years. In truth, they have had little option when faced by the “strong-arm” procurement policies of their clients, the most aggressive of whom include government departments.

Martin Davies
Martin Davies

The biggest consequence of the continued use by spending departments of the cheapest-is-best approach is that main contractors now put forward the lowest tender to win the contract and then devise ways to turn that into profit. They discount prices and then extract at least equivalent discounts from subcontractors; they sublet and offload risk to supply chains, insisting in Carillion’s case on 120-day payment terms — vastly inferior to the 30-day government terms; they claim against the client to increase the price and counterclaim against subcontractors to cut costs; and they deploy spurious grounds to withhold money due to subcontractors for months or years. As a result, subcontractors are pressured to cut their costs, thereby compromising the reliability or economic operation of the facility.

And, as minimal interest rates have reduced the profit from hanging on to subcontractors’ payments, Carillion and others competed harder to win more and more juicy contracts.

It is not as if the government was unaware of this. Ian Tyler, a former chief executive of Balfour Beatty, let the cat out of the bag seven years ago. In 2011 he told a government-sponsored conference that contractors were winning public sector business by offering the lowest tender and finding ways to make them profitable.

However, an alternative solution was included in the new government construction strategy that same year. Its proposals included trials for new procurement models, including the creation of virtual companies where the main and specialist contractors (who do the actual work) work together as equal partners, secured by integrated project insurance (IPI).

The Cabinet Office urged spending departments to volunteer pilot projects, but only Dudley College was interested. The departments either made excuses for not participating or their lawyers rejected the concept.

The IPI model creates an alliance, whose members are chosen for their quality and experience. It also ensures genuine collaboration and provides independent assurance that the plans make sufficient allowance for the risks. At its heart is the IPI policy, which provides no-blame cover for a cost overrun and defects for 12 years.

It was the protection against cost overruns, claims and even litigation that gave Dudley College the confidence to use IPI for its new training facility and to take an earlier decision to go ahead. The college’s reward was completion on time with costs 6 per cent below the investment target and work to a standard that it agreed was of at least as good quality if not better than expected.

The lessons from Dudley mean that further pilot projects should be able to deliver savings of at least 20 per cent in costs and 40 per cent of programme time.

A second pilot project has started in Derby and promises have been made for several more. But government departments still seem happy to continue in the same old way.

This lack of interest, even positive resistance, to a sustainable, viable alternative by those responsible for procurement says it all.

Martin Davis was vice-chairman of Emcor, the contractor, and is now integrated project insurance mentor for the Cabinet Office

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