How and why are the two questions I’ve been asked most this week.
How did it happen?
Why did it happen?
I am talking of course about the collapse of Carillion.
It is not a difficult question to answer. When you have a lot of debt coupled with a string of things going wrong, then it’s very easy to find your business is in trouble and it can happen very quickly, whatever sector you operate in.
We have all read the headlines and seen the press coverage. Whether or not you agree with some of the media referring to Carillion and the Government’s engagement bearing Ponzi scheme characteristics I have no doubt that there will be many businesses who will identify with being in a bid/proposal pitch where the desire to win the contract squeezes the profit margin substantially.
Unfortunately, whilst such won contracts may provide a short-term feel good factor and possible PR coverage they are not commercially sound for a sustainable and secure future, as evidenced by what we are witnessing at Carillion.
There will no doubt be a great deal of concern and empathy for the employees, suppliers and subcontractors who have been advised to continue to work and provide goods and services as normal, under their existing contracts, terms and conditions. Whilst they will be remunerated as usual during the liquidation period there is bound to be a great deal of concern around the certainty of this, not helped by media coverage and tabloid press exposing the kind of damaging news likely to fuel further trepidation. There will also be a great deal of ambiguity in the medium to long term surrounding the current outsourced contracts and whether or not these will remain with the incumbent firm or be taken over by new companies. Equally so, the predicted 10% cut in the Carillion employee’s pension scheme, will have a detrimental effect, especially on those aged workers with little time left to take alternative action to account for this loss.
The speculation and formal procedures of sorting out this situation will roll on for many months to come and as with all devastating circumstances, there will be lessons learnt along the way.
Large contracts with low margins, long payment terms and the risk of not being able to recoup cost escalation on significant overrun is endemic in the construction industry and awarding project contracts to shell companies, with no assets, outsourcing across numerous businesses in the supply change creates a highly exposed operation. When disaster strikes, the impact is not felt in just the immediate procurement pool, there are consequential effects too. Lenders, such as banks, will often unite in their opinion that the troubled industry is too high risk to support and credit insurers too may tighten up on their advances. Suddenly a wealth of funding options dry up just when the struggling company has a cash flow crisis, which can be a vicious circle.
Construction is a complex area with lack of solvency a common problem and a historical track record of being handicapped by risk. For those operating in the industry, where the economic risk is higher than many other industries and for whom the Carillion case has raised questions about the strength of their own organisation, there are steps to take to help to minimise this risk:
- Prior to contracting for a project, identify and analyse the likely risks involved and implement steps to avoid these. Please remember there’s always the option to take professional advice on how best to mitigate such occurrences
- Run checks on the financial strength of other parties you are trading with and set your credit limits accordingly
- Keep debtors at an acceptable risk level for the business
- Consider taking out credit insurance to protect against a customer being unable to pay; remember if the debt is not insurable, there is probably a good reason why not
- Avoid over reliance on any customer
- Ensure contracts are well drafted to make it clear who is responsible for paying for cost overruns and how this is to be agreed and funded
- Ensure contracts have adequate measures included for quick and efficient resolution
- Make it company policy to set an acceptable minimum rate or return for your service, thereby avoiding the experience of reducing fees beyond what is commercially viable to operate your business
- Ensure there are regular payment mechanisms on long term contracts and ensure these are set at a level sufficient to cover expenditure outlays
- Consider the opportunity for industry consolidation – would acquisition enable you to grow your business, enter new markets and become more financially robust to expand your services and capabilities? Again, I would recommend taking professional advice if this scenario holds any appeal.
- Equally, consider divesting of any parts of your business which are of low profitability or taking a disproportionate amount of management’s time
Despite the doom and gloom the Carillion news heralds the UK Construction Media appears optimistic about the sector’s future, citing 2018 as the year to encourage entrepreneurialism and further innovation in the construction industry and its prediction is that the sector will continue to evolve throughout 2018.
If their expectation transpires and Carillion’s demise becomes yesterday’s news there will no doubt be other companies stepping into its shoes. Following the results of dismal sales on the high street at Christmas, our papers will soon be filled with some high profile retail failures, closely followed by issues in the casual dining and hospitality industry more generally. All of this before we feel the full effects of Brexit on the employment costs in any of these industries. The world of restructuring is getting busy….