This week the UK’s 2nd largest construction company, employing an estimated 43,000 people around the world, went into liquidation. Three quarters of the company’s sales came from the UK, where many of the contracts were awarded by the UK government for such infrastructure projects as new roads and hospitals.
How did this happen, when Carillion were continually being awarded lucrative contracts from government and being paid for a large proportion up front? It seems that the intense competition for these contracts forced margins lower and lower. A “contractor’s 2% profit would not just be wiped out – huge losses could be incurred too.”
The company’s problems stem in part from cost overruns on three public-private partnership contracts: the £350 million Midland Metropolitan Hospital in Birmingham; the £335 million Royal Liverpool University Hospital; and the £745 million Aberdeen bypass.
Carillion’s demise is its competitors gain. On Monday, against a flat FTSE 100 opening, Serco shares climbed by 4.42 percent, G4S by 4.1 percent and Capita 4.65 percent. All organisations that have struggled in recent years, and are direct competitors to Carillon (or were).
Outsourcing labour, or outsourcing risk?
Putting aside the political fallout for a minute, I think this raises more general questions about outsourcing, and whether the perceived benefits are being realised. Some years ago, I read a study that when all the factors are taken into consideration, outsourcing delivers a two-to-three percent cost benefit. Additional advantages included the reduction in headcount, access to a larger talent pool and lower labour cost. However, there are other negative impacts, too. As in the case of Carillion, there is potential financial risk, communication issues between parties, quality problems and the impact on company culture.
I think outsourcing does bring many benefits, but it is not a one-off sourcing exercise. There is a need for a very mature approach to performance and risk management, and there is a need for a much deeper analysis on the supplier market and the most current dynamics.
What are the cost drivers impacting the supplier performance? Consider the current scenario: can the market sustain four large organizations competing for the same projects? How can all the data points come together in one place so the relationship manager can minimise the risks to their organization? It most definitely is not just about the initial cost, and not only about the total cost of ownership. It is actually about maintaining or improving the product / service, at a lower cost, while being fully aware of the complete risks involved throughout the life of the contracts and having contingency plans actively in place.
Nationalism turns to national crisis?
On a more political level, the Carillion collapse goes to the heart of many current nationalistic emotions around the world which have stemmed from the 2008 financial crisis. Bringing jobs back home is a common theme in countries across the globe. As with all knee-jerk overreactions, it papers over much deeper issues, like the growing anger over the widening disparity between the haves and have nots.
Regarding Carillion, nearly 28,000 members of the pension scheme will have their lifetime payouts reduced by about 15 percent. Contrast that with the chief executive who resigned last year, and who will be paid his £660,000 salary and £28,000 benefits for 12 months after his departure. This does not represent market forces and capitalism well. Unfortunately, the debate about outsourcing will be driven by this rather than about the benefits of outsourcing itself.
I spoke with a global leader in outsourcing a few years back. He said that his company was moving skilled jobs back from the East to Europe. But, unskilled jobs will remain offshore. Why? While there is now only a 20% wage differential for skilled labour compared to offshore, the gap for unskilled labour is still at around 80%. Even with a significant adjustment in exchange rates, unskilled labour will see little change in rates of earnings for many years to come.
That is the real problem that needs to be discussed, and unfortunately situations like Carillion mean outsourcing is becoming a victim of political agendas. The actual performance of the supplier needs to monitored continually, and performance targets adjusted to meet new market needs. In my view it’s all about supply base and performance management. Let’s agree on what “excellent” really looks like to the client or end user.
To hear more thought leadership from Sean, register for his upcoming webinar with Tim Cummins of IACCM and Michael Behne, VP of Professional Services at Determine. You can also catch up with his wide-ranging blogs on various industry topics.