Image credit: Terry Robinson Image credit: Terry Robinson

Last month the UK’s second-biggest provider of outsourced services to government went bust, leaving thousands of unpaid subcontractors in its wake. The latest information I have seen, says David Molian is a Visiting Fellow at Cranfield School of Management, suggests that unsecured creditors are likely to receive less than one penny in the pound - perhaps even nothing at all.

I followed this story closely as it unfolded. Even though the dust has yet to settle finally, there are evidently lessons to be learned: both specific lessons regarding bidding and contracting, and more general lessons about managing business risk.

Lesson One: If it looks too good to be true, it probably is. Carillion historically reported net margins above the average for its sector. Construction and its allied services is a low margin business. If a company is consistently outperforming its peers, there has to be a good reason. In reality, Carillion was not widely regarded as an exemplary business, with widespread complaints from subcontractors about late payment and excessive on-site bureaucracy leading to project over-runs.

Lesson Two: Turnover is vanity, profit is sanity, cash flow is reality. This old business maxim is as true today as ever it was. Carillion was heavily focused on the top line, and had grown through aggressive acquisition of other businesses. It seems clear, however, that what Carillion was buying was not so much other firms as their portfolio of contracts and future business pipelines. This strategy increased the strain on their cash flow and piled on the debt to unsustainable levels.

Lesson Three: You can operate sustainably on low margins, but only if the cash flow works in your favour. Take the supermarket sector, for comparison. This traditionally operates with margins comparable to construction, but generates positive cashflow. The customer pays at the checkout, but the suppliers of the goods purchased have to wait 60 or 90 days for payment. The supermarket has its working capital funded up-front. A major factor in the delayed payments to Carillion’s subcontractors was the time-lag the company faced in getting paid by its own customers.

Lesson Four: Too many eggs in the wrong basket. Carillion’s cashflow problems were compounded by its heavy reliance on government, a notoriously slow paymaster. Presumably, banks were prepared to provide interim funding on the basis that public sector customers do not go bust, and so will pay eventually, but the costs of bank debt have to be serviced and the business was inherently vulnerable to changes in interest rates.

Lesson Five: Diversifying the business portfolio does not necessarily equal reducing business risk. Its acquisition of other businesses took Carillion into other areas. On the face of it, this seems a good idea, especially for a large organisation. If, for example, the demand for new hospitals stalls, it may be balanced by an upsurge in demand for new schools, and vice versa. A delay in starts on new builds may be countered by a continuing need for maintenance and the supply of services. However, if the profile of the customers is broadly the same – ie they are all slow payers – the financial risk to the business has been raised, not reduced.

Lesson Six: Management capability has to keep pace with growth. Carillion’s expansion and diversification seems to have outstripped its ability to manage an ever-more complex business. By all accounts the depth and breadth of management in the company were insufficient to keep up with the demands of the business and the key competences of project management and engineering expertise were in short supply. The financial engineering that appears to have taken precedence over civil engineering surfaced in too many projects under the control of accountants who lacked the appropriate skills.

What could and should Carillion have done differently? Hindsight is, of course, a wonderful thing. But the implications of the lessons are clear enough. Three things pre-eminently stand out. First, going for growth does not in itself constitute a business strategy. In fact, the bigger you are, the harder you fall, and a company with half the turnover and greatly-improved cash balances would have been inherently more sustainable. Second, far too little attention was paid to managing the business risks that increase with growing size and complexity. Indeed, the financial statements that have emerged suggest that senior management is likely to have progressively lost sight of the basics in the struggle to make sense of the balance sheet and trading position. And third, management “bandwidth” was insufficient to handle the operating challenges created by Carillion’s overstretch.

Some readers of this column may be in the position of subcontractors to main contractors. For them, this sorry episode reinforces, in our view, key messages I will be stressing in the months to come:

- be clear about your strengths and align these with your bidding strategy

- do not fall into the trap of bidding for anything and everything, but subject candidate bids to a rigorous Bid/No Bid screening process: never, ever, find yourself saddled with the winner’s curse of landing a project you wish you had never tendered for

- prioritise wherever possible tenders with a strong Quality emphasis: successful bidders are less likely to be squeezed constantly on price

- when conducting your background research, ensure that you do basic due diligence on the target client, on their financial health, their payment terms and their reputation in the market for dealing with subcontractors. It is better to walk away than find yourself burdened with costs that you have little or no chance of recovering.

David Molian is a Visiting Fellow at Cranfield School of Management and the lead author of How to Write Bids That Win Business, to be published by Harriman House in March 2018.

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[1] Around 450 contracts, it is estimated – making the task of keeping track of project profitability incredibly difficult.