Carillion: lessons in major contractor’s predictable collapse

By David Donaldson

Thursday January 18, 2018

Carillion building site in Birmingham. Source: Elliot Brown, from Wikimedia Commons. URL: https://commons.wikimedia.org/wiki/Category:Carillion#/media/File:Carillion_in_trouble_-_Paradise_Birmingham_at_Chamberlain_Square_(25816239318).jpg

One of the United Kingdom’s largest public contractors has collapsed, leaving the government to work out how to ensure a wide range of services continue.

Carillion was responsible for building and maintaining services in schools, hospitals, military bases and major infrastructure projects. Delays in a handful of projects were apparently enough to fell the company, though it is still not entirely clear how this happened. The fact that it was given a £2 billion government contract soon after issuing a major profit warning last year has raised many eyebrows.

The company employed 42,000 staff, with around half in the UK and others in Canada, the Middle East and elsewhere. The government has reassured Carillion staff working on public contracts that they will continue to be paid, but other providers — public or private — will need to be found to take up the services Carillion was delivering. Subcontractors and providers owed money by Carillion may yet go bust themselves.

On top of the human and financial cost, the political fallout will potentially be far reaching in a country which already has a growing movement against public-private partnerships. “It is time to put an end to the rip-off privatisation policies that have done serious damage to our public services and fleeced the public of billions of pounds,” said Labour leader Jeremy Corbyn in a video posted on Twitter.

Only a matter of time

The collapse of a major contractor was “not only predictable, but predicted”, says ANZSOG professor Gary Sturgess, an expert in public-private partnerships in both Australia and Britain. He warned in a report last year under-bidding was being encouraged in a “game of chicken“.

It is unclear who will take over Carillion’s contracts at this point, but Sturgess says there are precedents in the UK for for the public sector and other private providers stepping in, whether temporarily or permanently. He worries, though, that the loss of trust between government and major providers in recent years may make it difficult to find replacements from the private sector. There’s also the possibility that contracts were initially secured through underbidding, which will mean new providers will only take them up if paid more.

While there are still major questions about what exactly went wrong and who is responsible, Sturgess has been concerned for some time about the UK government’s zeal for cutting costs through contracting with little regard to other factors.

There is always a risk of company failure when dealing with the private sector, but he thinks the UK’s “quite aggressive” approach to contracting has become “deeply perverse” in recent years, heightening the risk that something would go majorly wrong.

While many on the left are concerned about private sector profiteering, part of the problem is that the UK government has become very skilled at wringing savings out of contractors. They brought in people from the finance industry after the global financial crisis to drive a hard bargain and implement austerity, Sturgess explains. When competition reduces margins so far, small profits can quickly turn into losses when something goes wrong. If a company is poorly managed or is new to the field, the risk of that happening is increased.

The warning signs have been there for a while. The government has pushed for completely unrealistic savings in many areas, cutting flesh as well as fat. This led to “terrifying” things like companies with no prior experience with a service winning out over more experienced providers by entering significantly lower bids, according to the professor. The result is a contractor that may be running the service at a loss, and may not have the skill base to deliver it properly.

Economists and politicians like to talk about free markets, but most government services should not be thought of in such simple terms, Sturgess argues. They tend to be complex institutions delivering services to vulnerable or sick people, or crucial national services like defence. Unlike much of the private sector, they can’t just be allowed to collapse. As a result, government is often heavily reliant on an individual provider and is exposed if anything goes wrong.

Instead, government needs to approach such relationships as something more similar to a corporate supply chain, managing relationships, expectations and compliance on an ongoing basis and requiring serious consideration of factors other than getting the lowest price.

“It’s simply not good enough to have government tendering overwhelmingly by cost and turning a blind eye to the financial stability or sustainability of the company,” Sturgess argues.

“When I spoke to public servants in the UK many felt they didn’t have permission to say, ‘Excuse me but there will be consequences from driving down costs that much.’ There is always this incentive in the system to drive down the price through outsourcing, and this has to be resisted and fought,” he says.

“It’s been obvious for several years that this industry in the UK had gotten into a situation where both sides did not trust each other and both sides were gaming the system.”

‘Prime provider’ model increases risks

The collapse of contractors is unfortunately nothing new, says Melbourne School of Government professor Janine O’Flynn.

Governments must have a plan in place in case everything goes wrong.

The Carillion case “tells us that no firms are too big to fail, and that governments always need to maintain some redundancy in their own systems to be able to step into major service delivery mode when crisis strikes,” she says.

“Providers that become, over time, increasingly dependent on government funds are also risky. For example, they may lose major contracts in one jurisdiction (NSW) which impacts their ability to function in others (Tasmania); or in one service area (hospital meals) that impacts their capacity to deliver in others (school meals).”

Carillion is an example of the prime provider model, an approach often used in the UK. Under this model, government contracts with a lead provider which then takes responsibility for organising and managing service delivery through a group of specialised or local subcontractors, Flynn explains.

Governments like it because dealing with only one contractor lowers transactions costs. But it also means that if that company fails, “the reach of failure is broadly dispersed and potentially catastrophic in scale”, she says.

Governments seeking to cut “costs close to the bone” amplify these risks.

She finds it worrying that despite several decades of experience with contracting in the UK, failures happen reasonably regularly — in part thanks to a lack of investment in procurement and the skills required to design and manage contracts well, a problem also facing Australia and the United States.

“There have been various reviews and reports that show that the capacity of governments to commission and manage these relationships has not developed alongside the appetite for increasing the scale and scope of outsourcing,” she points out.

Australia not immune to bad practice

O’Flynn wouldn’t be surprised if Australia starts using the prime contracting model more in coming years, given our “strong tendency to mimic developments in the UK”.

Sturgess says that while Australia has had “a few big disasters” in outsourced service delivery — which, he notes, happens with fully public services as well — “we haven’t run as hard and fast” on public-private partnerships as the UK in recent years.

But he is concerned Australia might pick up the British habit of encouraging “simple models” and under-bidding to save money, something we’ve mostly avoided so far — probably thanks to being in better fiscal health.

“Periodically ex-ministers and consultants from the UK have turned up and tried to flog their practices here,” he says. “By and large they’ve been seen off, but some of that simplistic nonsense is still around.”

Image source: Carillion building site in Birmingham. Source: Elliot Brown, from Wikimedia Commons.

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Tim
Tim
2 years ago

“They brought in people from the finance industry after the global financial crisis to drive a hard bargain and implement austerity.”

This is not only in government and public/private circles but of course also in the commercial realm. A light needs to be shone on the ideological underpinning of financialisation.

Stefan Gassner
Stefan Gassner
2 years ago

I have recently helped establish a “prime contracting model” in the NSW Government. The project clearly defined the objectives first (“what do we want to achieve”) and made sure savings were not part of the reason why the project is undertaken. Second, price was not a weighted criterion for selecting the best provider. Instead, a risk assessment was undertaken to truly understand the value for money proposition. Of course, financial due diligence was also part of the process. Some simple steps to mitigate risk.

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