The Economist Asia - 20.01.2018

48 The EconomistJanuary 20th 2018

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1

L

ABOURERS building the new Midland

Metropolitan Hospital in Birmingham

got a rude shock when they arrived for

their morning shift on January 15th. They

were told to go home; they had been laid

off. Meanwhile, in Oxfordshire, the county

council was putting the fire brigade on

standby to serve school meals. Such were

just a few ofthe immediate consequences

of the collapse that morning of Carillion,

Britain’s second-largest construction firm,

with debtsof about £1bn ($1.4bn) and pen-

sion liabilities of almost as much again.

The total cost in lost jobs and business

has yet to be counted. Butanother casualty

of the company’s capsize may be the busi-

ness model that went so badly wrong

there, and which plenty of other firms in

the outsourcing industry share.

Carillion employed 43,000 people

worldwide, almost half of them in Britain.

It began as a construction company, build-

ing everything from the doughnut-shaped

headquarters ofGCHQ, Britain’s signal-in-

telligence agency, to hospitals and football

stadiums. Itlaterbegan providing all man-

ner of services for both the public and priv-

ate sectors, dishing up meals in schools,

maintaining bases for the Ministry of De-

fence, and much else. Many of its projects

were commissioned under the Private Fi-

nance Initiative (PFI), in which contractors

foot the cost of building and are repaid by

the government over several decades. Al-

most all the work that Carillion won was

the building trade. In Liverpool, for in-

stance, workers found asbestos on site and

cracks appeared in the new building. Un-

der the terms of the deals, Carillion had to

absorb the extra costs, on projects that

were barely profitable in the first place. The

company also ran into trouble in Qatar,

where it got into a dispute over a payment

of £200m that it was owed for work on the

2022 World Cup. The result was a profit

warninglast July, afterthe company admit-

ted to unexpected over-runs of £845m,

which sent the share price tumbling. Caril-

lion continued to win business, notably

from the government, which awarded it a

contract for £1.4bn of work on the HS2 rail-

way even as investors bet on the firm’s col-

lapse. But after more profit warnings, the

banks refused to lend it any more.

Public-sector tenders are supposed to

consider the quality of bids aswell as the

price, but in practice contractors have

found that “bidding at a low price is usual-

ly the best way to win,” says Peter Kitson, a

lawyer at Russell-Cooke. Companies bank

the upfront payments and hope they can

make money by charging for the extra

work that nearly always comes with infra-

structure projects. If, as happened to Caril-

lion, extra costs arise, the deal can quickly

become loss-making.

But Carillion’s management was also

culpable. The firm expanded too fast, ac-

quiring businesses that it did not under-

stand. It paid £306m for Eaga, for instance, a

supplier of green-energyproducts, only

months before the governmentcut subsi-

dies that homeowners got for installing so-

lar panels. As Carillion was failing and its

pension fund slipping into deficit (see next

story), shareholders continued to receive

dividends and the firm’s boss trousered a

£1.5m pay package. Even the Institute of Di-

rectors, a business lobby, condemned Ca-

rillion’s board for rewriting company rules

outsourced to subcontractors, who would

often sub-subcontract it in turn.

The platoons of small firms that did

most of Carillion’s work will thus be most

affected by its demise. Rudi Klein, head of

the Specialist Engineering Contractors’

Group, representing thousands of engi-

neering firms, estimates that Carillion

owed about £2bn to 30,000 or so firms.

That does not include the unknown cost of

retentions, the cash that Carillion was

holding back until companies had finished

the job. Many will never get their money,

damaging Britain’s slender supply chain.

At least the government has stepped in to

protect those doing public-sector work; Ca-

rillion had about 450 government con-

tracts, constituting about a third of the

company’s revenues in 2016.

But it was this work that contributed to

Carillion’s undoing, highlighting the basic

flaw in its business model. Construction is

a perilously low-margin business to begin

with. To expand the business and keep

enough cash rolling in to pay creditors and

shareholders, Carillion’s bosses bid ever

more aggressively for public-sector con-

tracts, especially in the wake of the finan-

cial crash in 2008, when such work was

scarce. That is when three big deals were

signed that have gone sour: to build hospi-

tals in Liverpool and Birmingham, togeth-

er worth £685m, and for a share in a £550m

roadbuilding contract in Aberdeen.

All three projects hit snags common to

The collapse of Carillion

Cleaned out

The mega-contractor’s demise reveals an outsourcing model in need of a revamp

Britain

Also in this section

49 The tabloid Guardian

49 Carillion’s pensions

50 Bagehot: The special relationship