In the wake of the spectacular collapse of the construction and professional services giant, what action can be taken by procurement professionals to guard against over-exposing their purchasing portfolio to the risk of non-delivery through contractor insolvency?
Begin with the Basics
Carillion’s UK losses largely came from huge write-downs on just three public-private partnership projects. Despite forays into alternative sectors, Carillion – the UK’s second biggest construction contractor- still lacked the scale or diversification to be able to absorb the impact of the £845million write down on major contracts suffered alongside its July 2017 profit warning.
Contrastingly, some of the largest contractors in Europe such as Hochtief of Germany or Vinci and Bouygues of France all turnover well in excess of £30bn and are diversified – both in terms of the clients they work for and the projects they take.
Protect your category from over exposure to suppliers by implementing the 30% rule – avoid committing more than 30% of your category spend to a single supplier whilst ensuring that the supplier doesn’t rely on your company for more than 30% of their turnover.
These simple checks should be relatively quick to complete – we recommend you begin to build a database to increase speed – and provide a red flag for buyers. In some industries and categories it won’t always be practical to exclude a supplier when a project is imminent, but heeding the warning sign and developing competition in the supply base will bear fruit not only for the security of supply but the value and innovation brought to the table.
Implementing the 30% rule when compiling your bid list will help avoid difficult conversations down the line.
Activate Continuous Supplier Health Monitoring
Whilst the future is impossible to predict, Carillion's plight rang major alarm bells at least six months prior to its insolvency.
Procurement departments and professionals who engage in ongoing supplier health monitoring put themselves in the driving seat when it comes to anticipating and planning for supplier insolvency.
Credit checks and complex financial ratios are often used as a bona fide barometer of supplier financial health, but whilst buyers who are highly category focused may be skilled interpreters of these seemingly meaningless figures, even the credit agencies themselves struggle to find any real reason to monitor the often snail-paced trends of supplier credit reports.
Despite this, monitoring key and relevant metrics isn't a futile excercise. Keep it simple, keep it flexible. different industries have different benchmarks and norms - the construction industry for example carries far lower margins and less cash than the digital marketing industry. Setting a company-wide benchmark will only serve to limit your supply base and infuriate your stakeholders in the process.
There is a proactive and accurate way to monitor supplier health - straight from the horse's mouth.
Encourage Key Suppliers to Share Distress Signals
Although declining to bid on most major new tenders, Carillion continued to reassure clients of the firm's commitment to their contracts and sectors.
Whilst their predicament may have been a lost cause, this behaviour is typical of suppliers in all industries, fearing the inevitable truth of being cast aside by buying organisations and excluded from bidding for future contracts.
By far the best way to manage supplier health is for suppliers to inform clients themselves of any difficulties - financial or otherwise - and work openly together to secure continuity and consistency of supply.
In manufacturing, most OEMs are aware of the 'weakest link' in their supply chain and actively manage that tier of the supply chain to reinforce its stability. These are typically suppliers of 'bottleneck' parts or components and are often smaller companies. As such the improvement to cash flow that results from, for example, condensing payment terms shorter than a firm's standard term, can be pivotal for the supplier. The resulting on-cost to the buyer is insignificant, especially when compared with the switching cost of the part.
The particular scenarios which may be suitable arise on a case by case basis may not be apparent to the OEM. For this reason, the best organisations encourage their suppliers to approach their buyers with concerns before the situation becomes unmanageable. Fostering this openness requires reassurance that the supplier won't face penalty - in the form of lost business - as a consequence of voicing their concerns.
By adopting this approach, other organisations can reap the benefits of a secure supply chain such as security of supply, reduced costs of sourcing, consistency of product or service delivery and an enhanced working relationship.
Create Sustainable and Smart Award Criteria
One of the main criticisms lobbied at Carillion was their acquisition of contracts at prices perceived to be below market value.
Whether or not this is really the case only a select few will know for certain, but what is certainly true is that the practice is endemic in the regulated world of public sector and utilities procurement. Award criteria for tenders are typically set on a Most Economically Advantageous Tender or "MEAT" basis, meaning that employers need not award bids to the lowest cost contractor. However, in reality the tendered cost is invariably the single largest factor in the award decision, owing to the obligation on the buyer to secure value for the consumer.
Construction contractors in particular rely on their pipeline of contracts to cover their substantial fixed costs and keep their staff in a steady state of employment. Consequently following large jobs, there is often a need to continue to win work to 'feed the beast.' Winning work under MEAT requires an established and demonstrably more valuable technical proposal than other bidders which is often difficult to deliver under constrained tender timelines. Thus, winning work often comes down to submitting the cheapest tender and accepting more project risk in the process.
Not only does this cycle routinely result in out-turn costs for projects that bring red faces to all involved, it can ultimately lead to supplier failure - either on the project itself or in the macro-environment as seen in Carillion's case.
Often the response from the employer is to allow some or many 'in contract' claims and changes which may strictly sit as the contractor's risk under the agreed contract. This solves the immediate problem but only serves to perpetuate the problem in the long run.
The answer is paradoxically simple and complex at the same time: award contracts to those bidders who return realistic, competitive, robust solutions for projects.
Whilst procurement regulations do make allowance for excluding unreasonably low bids, this is fraught with danger for employers understandably fearing challenge from dissatisfied bidders.
The optimal solution is to construct such award criteria that accurately promote robust submissions whilst recognising the requirement to deliver consumer value. Decide what are the most important factors for delivery and award credit for innovative solutions that mitigate risk. Commercial submissions will always have a large role to play but undertake rate analysis against previous projects, query anomalous rates and utilise quantity surveyors where appropriate.
In order to reduce evaluation bias, many regulated organisations keep their technical evaluation teams wholly in the dark when it comes to the commercial submissions. Conversely, involving them in the commercial analysis can help uncover where productivity rates have been over-optimistically estimated or activities missed from the programme.
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