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Carillion - Making Sense of Public Sector Procurement

January 16, 2018

 

It is rare that the collapse of a company receives such widespread media attention, but when it employs almost 20,000 people in the UK, it becomes a matter of national obsession.  The frenzy seems to be concentrated on two key points: a failure of corporate governance and the company's relationship with central government and the underlying failures inherent in public sector procurement.  

 

The first is an easy (if lazy) target for the media as it conveniently portrays company directors as evil, cigar-smoking corporate 'fat cats' who seemingly move from company to company, principally through cronyism, causing havoc and devastation, without any criminal or civil penalty.  Not that I condone idle or self-serving leadership, rather the opposite, but it is an unimaginative and tired, if popular, narrative used to sell news stories. 

 

The second, however, is rather intriguing, and it has whipped up a storm within the trade union movement, with commentators rushing to issue universal condemnation of the way central government issues works' contracts.  However, it's really an issue of a misunderstanding of the fundamental economic pressures facing each manager with any control over the public purse.  This sense of shock over the conduct of civil service procurement is becoming a convenient scapegoat for failure of a private sector company, and raises broader questions about the pragmatic functionality of Public Private Partnerships.  As a previous officer and board member in companies that have been heavily reliant on government contracting, both in the UK and elsewhere (most notably in the US), I am not at all surprised that this issue is causing some groundswell.   

 

Fundamentally, the selection of contractors for work by government procurement departments have both a qualitative and a quantitative scoring component.  This is often managed through two decision rounds, often with different personnel making the down-selection for each, with the qualitative usually preceding the quantitative.  The qualitative metrics will relate to the company's ability to demonstrate its competence to deliver: this will involve the company listing its completion of previous, similarly scaled and scoped projects, its relationships with its supply chain (second and third tier subcontractors), and its financial structure and stature (financials may be included in the quantitative submission).  It will also typically involve the submission of the contractor's operational plan for completion of the specific works order.  The quantitative round is focused almost entirely on budgets and pricing.  Now, there are inherent weaknesses that can be built in the system, based on the weighting applied to the scoring.  Quite often, the quantitative scoring is disproportionately weighted, maybe up to 70-80% of the entire grade.  And often the qualitative round is not a stage-gate as to whether a specific proposal will be submitted for consideration at the quantitative stage.  Procurements are most successful where the procurement team independently assesses the qualitative submission first and only allows companies that reach a requisite minimum score, into the second (quantitative) round.  Where procurements are at risk, this is not a yes/no process and ALL submissions are considered for award regardless of qualitative score.  If the quantitative score is a disproportionately high element of overall score, the selection can end up going to the lowest bidder, regardless of their ability to deliver the works program. 

 

In my experience, government-hired subject-matter experts are involved heavily in the qualitative processes (both in writing and reviewing) but often ignored in the quantitative scoring process, because it is seen as inherently objective and not reliant on a review panel's collective experience or opinion.  Quite often, the qualitative bar is set too low, in terms of demonstrable competence of delivery, which allows part-qualified (or higher risk) companies to compete.  Of course, companies with lower internal mechanisms for quality control and fewer layers of management oversight, would be, ceteris paribus, cheaper in their costs structures and be able, therefore, to be more price competitive. 

 

This can be further complicated where there are quotas are in place to ensure that a fair distribution goes to a particular type of business, such as with the introduction of SME (Small and Medium-sized Enterprises) quotas.  These quotas exist heavily in US and EU governed projects.  When Hillary Clinton took office as Secretary of State in 2009, policies were introduced to push 25% of all Federal contract spending into registered small companies (as an attempt to stimulate a speedy recovery of the economy).  Any strategic policy will have unplanned consequences at the operational level.

 

There is no getting away from the fact that free market economics have played a part in Carillion's demise.  As there have been increased pressures on central government budgets, there is an enormous knock-on pressure in the civil service to get "as big a bang for your buck" as possible.  Public sector procurements are notoriously low margin, and lower still the larger the project as departments calculate the nominal value of the profit.  Companies are even prepared to enter loss-making contracts for prestige, or as an offset against greater access and influence within key new government departments in anticipation of winning lucrative contracts in the future.  This is seen as a legitimate practice, where near-term profits will be sacrificed for longer-term success.  Whereas this corporate risk taking is being broadly condemned as irresponsible and reprehensible, it is common practice for most large contractors.  Simply put, if this practice didn't exist, many companies would lose market advantage as some members of the competitive field will always be prepared to take the gamble.  These are normalised cultural business markers within the UK economy and nothing is ever said when these tactics pay off.  Occasionally they don't, and then it's headline news, as with Carillion. 

 

Even collusion is becoming increasingly prevalent in some restricted markets. Where there is a de facto oligopoly in a marketplace, competitors will actively seek to control pricing with one company bidding high to another's lower bid, switching roles back and forth between proposal cycles, to deliberately shape the result.  This is especially the case where there are only one or two businesses who can realistically compete for a procurement.  These sorts of activities are clearly both immoral and often outlawed by procurement regulations, but still exist.  With large government procurements, often worth hundreds of millions of GBP in revenue, there are often only a handful of companies that can demonstrate adequate past performance to be able to pass the qualitative threshold, naturally encouraging some collusive practices.

 

On top of all these inconsistencies and vagaries, there are human survivalist instincts that impact on public sector procurement decisions.  In smaller departments, with an ever-increasing need for efficiency, and with semi-automated procurement practices requiring less and less human oversight, critical procurement decisions can often be made by a very small number of people.  Given the choice between awarding a contract to a known, pre-qualified contractor with a long-standing history and good evidential record, and a less well-known new partner, a natural human instinct is to 'go with what you know', even when the long-term partner is struggling to fulfil existing contracts or starts to show the signs of financial hardship.  Besides, if something then goes wrong on the contract, no-one can really question your decision-making, right? 

 

Many single awards are now bundled up into longer-term contracting 'framework agreements', where contractors will pre-qualify for a long-term (usually 3-5 year) program of works.  In this instance, a single major procurement is made, at the start of the process, to select a number of companies for future awards of a similar scope or scale.  In many ways, this appears to be an efficient process.  The arduous round of due diligence only needs to be completed once.  After that, work orders are issued for specific projects and the incumbents respond in mini-competitions on each occasion.  As such, the process for selecting a particular contractor for these smaller projects is truncated, and the need to revisit the due diligence is often omitted.  Hence a company that appears to be in financial difficulty, through releasing profit warnings or publishing weak financial results, may still be invited to compete for new awards within the scope of any framework agreements in which they already participate, as they have already been seen to have passed the selection process.  This creates a culture of complacency, with procurement officers and departments tending to look less closely at a specific company's financial performance during the lifetime of a particular framework agreement as it, perhaps wrongly, assumes that the need for due diligence no longer exists. 

 

What is worse still is that there is often a prescribed agenda to award task orders on a rotational basis to each pre-qualified company, to keep them engaged and interested in reapplying when the time comes to re-compete for the header solicitation.  After all, a procurement department needs quality contractors as much as the contractors need contracts, a potentially toxic co-dependent relationship.

 

So when you look at these pressures as a collective whole, there are many points at which failure can creep in.  Of course, we can all argue that proper management and oversight of any process will always identify and mitigate the risk of failure.  But that's an easy, retrospective, throw-away comment re-peddled after the fact.

 

There are solutions.  Not that I claim to be a huge fan of the United Nations as a whole, but I did learn some valuable lessons some years ago at a UNOPS (United Nations Office for Project Services) procurement conference for suppliers in New York.  Principally, the UNOPS will immediately discount and reject the top and bottom priced 20% of the proposal pool.  So, for instance, in a field of ten qualifying proposals, the top two and bottom two prices will be eliminated.  Now obviously, in order to manage a competitive pricing exercise, it is clear why the top two are thrown out, but perhaps less clear why the bottom two are removed from consideration, as it appears initially incongruous.  This is because there will be an prima facie assumption that the margins built into the bottom two priced offers could put those contractors at financial risk if they were selected for the project, especially if the project value is disproportionately high compared to the company's overall revenue.

 

This principle is explicitly built into US Federal procurements.  In the US, all government contractors operate under very strict written guidelines in the FAR (Federal Acquisition Regulations).  This is an incredibly detailed and complex set of rules that have been constantly criticised for adding a huge administrative cost burden on compliant companies, essentially making them less competitive in overseas markets.  The industry is also backed by a voracious DoJ (Department of Justice), where hordes of young, hungry public-sector attorneys are looking to make a name for themselves by bringing down a corporate giant.  As such, government contractors must make it explicit what their margins are on their proposals, to an officious level of detail against almost every line item.  What this does do, at least, is ensure transparency in cost comparison and makes it very easy for a procurement department to see the financial impact a contract will have on every proposed contractor.

 

Would this have saved Carillion?  Of course, it's hard to say at this stage, and depending on the levels of investigations to follow, I would hope that these issues are explored in more detail.  For the moment at least, the ease at which the blame is being attached to central government failings and corporate greed is a convenient way to raise the temperature of the debate.

 

 

 

 

 

 

 

 

 

 

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