Carillion: the lessons for business and government

Carillion sign in the nighttime

With the giant service provider in liquidation and fellow contractor Capita losing more than half of its market cap, these are dark days for the outsourcing industry. Edwin Morgan, the IoD’s director of policy, sheds light on Carillion’s collapse and its consequences – and suggests a way to safeguard the private sector’s delivery of future public projects

At 6.40am on Monday 15 January, after a 40-minute hearing conducted over the phone, a High Court judge in London issued a winding-up order for what had, until then, been the UK’s second-largest construction contractor. With that, Carillion was handed over to the official receiver to see what could be rescued from the ruins.

Specific reasons as to why a firm with annual sales exceeding £5bn in 2016 could fail so spectacularly were in short supply when a Commons inquiry dragged a number of former directors in front of two select committees. Emma Mercer, chief finance officer at Carillion in the four months leading up to its liquidation, euphemistically blamed a series of “unfortunate events on some very large contracts that meant there was huge cash pressure”.

She pointed in particular to the Msheireb Downtown Doha construction project in Qatar, on which the firm claimed it was owed £200m. The Qatari developer disputed this version of events, arguing that it had continued to pay Carillion even though the works had fallen behind schedule.

Whatever the truth of the matter, the upshot was a big hole in Carillion’s finances. When combined with delays on three large UK contracts – the £350m Midland Metropolitan Hospital in Birmingham, the £335m Royal Liverpool University Hospital and the £745m Aberdeen bypass – the result was an unmanageable debt (about £1.5bn when the company went under) compared with the amount of money coming in. Big or small, no business can avoid this irresistible logic forever.

The immediate effect of the liquidation was to cast doubt on the futures of the company’s employees, including their pension entitlements; the thousands of subcontractors used by Carillion; and the big projects commissioned by its clients in central and local government. Over the following weeks the official receiver sifted through a mass of contracts, trying to keep some running but ending others, resulting in about 1,000 redundancies at the time of writing.

The former bosses who were grilled in Parliament ascribed Carillion’s failure chiefly to problems in its construction division. The other side of its work was delivering services including facilities management for public-sector clients. Many of these contracts remain viable. The official receiver has been able to save nearly 7,000 jobs in areas such as cleaning and catering in military bases and prisons.

Procurement problems

This case has become part of a broader, politically charged debate about how public money is spent on private-sector contracts. The TUC’s deputy general secretary, Paul Nowak, for instance, called Carillion a “textbook example of the failures of privatisation and outsourcing”. Sloganeering aside, we need to ask ourselves what this sorry tale means for the public sector’s procurement practices.

The government doesn’t build anything itself, so it’s no surprise that it uses firms like Carillion for public construction projects and will continue to do so. The crucial service that its so-called strategic partners provide here is to take on the difficulty and risk involved in finding the sometimes hundreds of subcontractors required to complete a large and complex scheme. The profit margins on this work are very thin – a factor in Carillion’s demise.

Ironically, the construction contracts that brought down Carillion are not what is typically meant by privatisation or outsourcing. The firm had been involved with schemes under the private finance initiative (PFI), but it was trying to exit this market, which it considered too risky. By coincidence, only days after Carillion’s demise, the National Audit Office published its assessment of the costs and benefits of PFI and its successor, PF2. The report found that there are about 700 PFI/PF2 deals in operation, with a capital value of £60bn. But they represent a small proportion of the government’s capital expenditure: over the past two decades such schemes have been worth about £3bn annually on average, compared with a publicly financed capex of £50bn a year.

A way forward

It is simply a fact that the government will continue to need the private sector’s help to build roads, railways, schools, prisons and other public facilities it has to provide. The public-private funding partnerships that ministers have tried can be beneficial, but the vast majority of projects will continue to be financed directly by public money. The question is: can anything be done to give the government more options with respect to how they are delivered?

Roger Barker, the IoD’s head of corporate governance, has suggested that policy-makers could create a new legally defined corporate form: the public service corporation. Such entities would operate on a commercial basis, but their underlying legal framework would require a balance to be maintained between the interests and obligations of their various stakeholders – employees, pensioners, creditors and public-sector clients – as well as shareholders.

Crucially, the appointment or dismissal of directors would be a matter not only for shareholders, as is currently the case under UK law, but also for other key stakeholders. It’s no silver bullet, but it would create a new model of competition for the construction projects and other commercial relationships that the government has to undertake.

Spending public money on the private sector

According to the National Audit Office, the public sector spent about £250bn through its commercial relationships in 2015-16, representing a third of its total expenditure. Among central government departments, the Ministry of Defence and the Department for Transport are the biggest spenders, shelling out £20bn and £13bn respectively.

Tussell, a provider of public procurement data, calculates that Carillion was the government’s ninth-biggest supplier by contract value in 2017.

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About author

Edwin Morgan

Edwin Morgan

Edwin Morgan is interim director general at the Institute of Directors. His team of policy experts covers issues ranging from tax and regulation to trade and infrastructure.

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