Carillion’s collapse highlights the risks of the government’s dangerous over-reliance on public procurement frameworks that favour just a handful of mega-contractors, writes Jane Renton.
There’s a strong sense of déjà vu about the events of recent weeks. We’ve been here before, or near as damn it, in the run up to the fearful unravelling of much of the British banking system during the tail end of 2007. Such was the enormity of the threat then that the government got well and truly stuck in; the Bank of England’s money printing presses went into overdrive and all of a sudden the banking crisis was averted. The emergency measure of quantitative easing designed to stave off collapse has become the norm ever since. It helped the bankers mend their bloated balance sheets, it also helped the government diminish its own debt pile, but it did little to help the taxpayer who has seen further devaluation in the purchasing power of paper money, particularly of sterling, as well as the diminution of their savings.
There will be no public bailout of Carillion, however, as ministers have stated, but the concept of ‘too big to fail’ still clearly exists. Yet the government has said it will provide the funding needed to ensure that the extensive array of public services that Carillion provided keep on running. These include contracts involving 14 NHS Trusts; HS2, the high speed railway between London, Birmingham, Leeds and Manchester; maintaining approximately 50,000 properties for the Ministry of Defence; managing nearly 900 schools; maintaining half of the UK’s prisons; and being the second largest supplier of maintenance services to Network Rail. Government contracts are believed to have accounted for about a third of its revenues.
The shockwaves are still being felt, particularly among the 28,000 members of Carillion’s savings and pension scheme, who now face great uncertainty over their retirement income. They are also being felt by the many thousands of small firms who acted as sub-contractors to Carillion and who are unlikely to ever receive all the money they are owed. Many are now facing bankruptcy of their own. Nor is the sorry saga over for colleagues and associates in estates and facilities in the NHS who are now heavily engaged in putting together contingency plans to ensure that services continue to be provided in each of the 14 Trusts directly affected by Carillion’s collapse.
As Margaret Hodge, former Chairwoman of the public accounts committee and a critic of the government’s reliance on a handful of major companies for the overwhelming majority of its outsourcing work said, Carillion’s collapse would end up costing the British public dearly. “Wait and see. I think there will be a massive cost to the taxpayer from what has happened,” Hodge told the BBC.
What went wrong?
Just why did Britain’s second largest construction company fail so spectacularly? Well, cash flow was clearly an issue. By the time the company collapsed it had only £29m of cash reserves left - hardly reassuring given its £2.4bn of liabilities.
Amid the debris of the collapse fingers have been pointed at Carillion’s leadership with fat cat bosses, overly risky expansion between 2012 and 2016 that led to net debt to equity doubling from 15% to 30%. Against this dangerous backdrop it seems that several projects began to go wrong at the same time, creating something of a perfect storm. But where Carillion seems to have really come unstuck was its aggressive pursuit of public sector contracts, which accounted for about a third of its overall business.
Moreover, the government itself doesn’t exactly come out of the crisis scot-free. Questions remain as to why it kept awarding yet more contracts to Carillion, some of them just weeks away from its eventual collapse, and despite a series of profit warnings. Presumably, ministers and officials thought they could help Carillion get over its current difficulties by shovelling through more work. If so, this is hardly encouraging. It suggests that government was complicit in something of a giant Ponzi scheme, whereby an institution uses new money to prop up existing failing contracts. It certainly suggests that due diligence on public procurement was less than adequate.
Fundamentally it boils down to the way that public contracts have been awarded under PPP (Public Private Partnerships) since 2010 when the Coalition government took a long hard look at existing PFI arrangements as part of an urgent need to cut the budget deficit. From thereon Whitehall became a lot stingier in the way it dished out new PPP contracts.
Carillion initially benefited hugely from its early work on PFI contracts. In 2006 it sold its stake in some eight PFI deals for nearly double their book value, making a £22m profit. Those stakes in two prisons, various court houses and schools in Leeds, were eagerly snapped up by pension funds and other investors attracted by the virtually risk free returns they offered over the terms of the contracts, which in many cases ran for some 25 years.
But that all changed. Austerity combined with PFI made for a far more difficult environment. Private companies were required to provide services more cheaply, and all too often quality suffered. Colleagues on the estates and facilities management side of the NHS frequently refer to the cat and mouse game played between supplier and contractor.
“They try and cut back on quality in order to improve margin and hope we won’t notice. If we catch them, we fine them and then they end up losing money on the contract,” explained one senior estates manager.
Too few fish in the sea
This race to the bottom, which undoubtedly contributed to Carillion’s demise, was predicted with remarkable prescience in the last issue of HEFMA Pulse by Business Consultant Julian Fris, founder of Neller Davies, who warned that government framework agreements had limited competition. Recent tender bids in the NHS were predicted on profit margins as low as between 1% and 2%, he said. It is hardly surprising that oligopoly, with over-reliance on just four or five private companies has resulted in recent public tender contests.
Moreover many of those companies, which also included Carillion before its spectacular implosion, include outsourcing firms G4S, Serco, Mitie, Capita and Interserve, all of whom have been beset by problems - hopefully of a lesser nature than those of Carillion. Yet all are reliant to a large degree on a public sector that has little money or for that matter, strategic direction.
It seems incongruous that George Osborne, who, as the then Chancellor was architect of the new PPP austerity, should now decry the lack of smaller and mid-sized companies from government contracts.
As Editor of the Standard newspaper, he asked: “Why has the state found itself so dependent on a few very large outsourcing firms? The failure to use a variety of smaller, mid-size companies undermines innovation and leaves services hostage when things go wrong.”
So what should the government be doing now, apart from praying and hoping that there are no more potential disasters lurking on the outsourcing front?
Scrap the PFI, says Labour Shadow Chancellor John McDonnell: “The scandal of the Private Finance Initiative has resulted in huge long-term costs for taxpayers while providing enormous profits for some companies,” he declared last September.
That may have been true before 2010, argues Fris, but it’s certainly not the case now. It’s true that earlier PFI deals cost many UK public bodies dearly and tied them into inflexible contracts that imposed high costs for finance and high fees for maintenance. But we’ve swung from one polarity to the other, where all the risk is placed unsustainably with the private sector and deters all but the largest corporates from participation. And the clear danger, as we’ve now seen with Carillion, is that those multi-sector companies leverage up their debt to grow their balance sheet, using profits from one sector to cross-subsidise losses in another area.
Ironically, some of these contracts have been sold on to pension and investment funds for quick cash to cover losses. Yet they are still erroneously viewed by many investors as a safe return, offering long-term predictable growth.
However, any attempt to bring the PFI back in-house is likely to prove highly unrealistic, for whichever party is in power. For a start the cost of buying out those contractual agreements would be prohibitive and there is not the capacity or expertise in place to handle them, even if were affordable. Since the PFI came into existence under John Major’s government, there have been 716 PPP projects with a total capital value of £59bn, according to the recent Treasury figures. The NHS alone has relied heavily on such schemes, with 127 PFI deals valued at £13bn in 2017.
What needs to change?
Longer-term thinking and reform, which involves more SMEs, is clearly needed: “You can only defer risk for so long and the ultimate guarantor of such schemes as far as the NHS is concerned is the Secretary of State for Health,” asserts Fris.
“The government needs to start realising that small is beautiful. Yes, risk has been pushed on to a handful of large contractors, but a bodged contract still leaves the government holding most of the risk,” he adds.
Fris says that while it’s been a sad few weeks for the staff of Carillion and those of other involved suppliers, the collapse of Carillion could inadvertently turn into a positive for the industry. It will focus public attention on outsourcing and the skewed way that it is currently undertaken. Total FM contracts might inevitably disappear or at least change the way they are delivered.
“It’s an opportunity to force the NHS to take more control and use the supply chain to handle services such as cleaning and catering. It can’t just be left to lawyers and accountants to handle,” he asserts.
The idiotically cheap tenders of the past will have to disappear. Costs are likely to rise. There will inevitably be a lot more self-delivery, especially within the NHS. This will be challenging, given that there are severe talent shortages in an organisation where only half of its services are outsourced. A lot of expertise has been lost from the health estates and facilities.
“The STPs (Sustainability and Transformation Programmes) could provide some guidance on this if they work together,” says Fris. “They might be able to deliver a different approach and could potentially consider a managing agent model, controlled in-sourcing, the establishment of public sector mutuals or an element of all three.”
The current situation also demands better competition law. The current state of oligopoly is neither fair nor desirable. More than £200bn a year is spent by the public sector on procurement of goods and services from third parties, but very little of it - less than 23% - is spent with small and medium-sized firms, according to a recent survey by the Federation of Small Businesses. This is wrong. The NHS, as Britain’s largest employer, is used and belongs to everyone in the nation. Its work should not - and in fact cannot - be kept in-house, but neither should it be the preferred domain of a handful of global behemoths that have accrued political power and money as a perverse side effect of the new Neoliberal world order. Moreover, innovation and flexibility is generally found in greater levels among smaller companies.
Government needs to get over its preference for dealing with its friends in big business. It may be easier to deal with a company the size of Carillion who can operate in many diverse areas than to deal with inexperienced smaller companies across numerous different sectors. However, as Carillion’s demise has shown, when things go wrong on this scale the consequences can be dire.
Action and reform is needed. Inertia is not.
