Are contractors putting the squeeze on the supply chain?

If you’re a subcontractor, opening the post these days can be a risky business - you never know what it could knock off your annual profits. Like, for example, when you get a letter like the one the subcontractors of facilities management firm Europa Services got recently. An epistle signed by commercial and finance manager Paul Witter “required” all of them to sign a form accepting a discussion or implementation plan for “a real cost reduction in planned preventative and reactive maintenance costs for 2011 of between 5-10% as part of cost-saving plans”.

Europa accompanied the request with a sort-of apology: “We appreciate this will not be well received when we are all enduring the current pain of the current economic climate.” Others have not been nearly so nice about it.

Europa’s letter, though probably not welcomed by suppliers, stopped well short of stating that subcontractors that didn’t agree to its demands would be jettisoned. Sources say other main contractors haven’t been so shy. There is growing evidence that main contractors are regularly requesting cost savings, rebates, or even prebates - money paid in advance on the basis of likely future workload - from the specialists and subcontractors working for them. The practices are seen by many as unethical and, depending on the situation, can be illegal.

Giant facilities management contractor Serco was forced last week to retract its request for rebates after being outed by a national Sunday paper, but Serco is far from alone. And while FM contractors have so far been responsible for most of this behaviour, after being squeezed themselves on government contracts, there is growing evidence that construction contractors have started doing the same.

According to the Specialist Engineering Contractors Group (SECG), the practices, which it says have developed over the past 12 months, take a number of different forms. In some cases contractors are demanding fees of as much as £10,000 up front in return for places on non-exclusive tender lists; in others, they are demanding rebates from firms that have already been given FM contracts. Worse still, some rebates are being applied retrospectively, for work already done at an agreed price. Prebates also take different forms, with preferred listing fees sometimes based on the value of existing orders.

The SECG says some of its members have been told outright that they will get no more work if they don’t agree to changes in terms. It also alleges that a lot of the time the end client is unaware of the practice, which means there is no guarantee that any saving is actually being passed on to the customer.

It’s not just the SECG that has noticed unsavoury practices. Suzannah Nichol, chief executive of the National Specialist Contractors Council (NSCC), says the organisation has had an influx of similar reports in recent months - from construction as well as FM contractors.

The practices seem to be more widespread among FM contractors, because of the long-term and repeat nature of work. In addition, construction contractors have been excluded from the government’s cost saving programme, whereas FM contractors, such as Serco, have been hit hard.

Simon Tolson, senior partner at law firm Fenwick Elliott, says that if a main contractor unilaterally amends the terms of an existing contract it would be a simple breach of contract law.
However, that doesn’t necessarily mean it’s any easier to decide what to do: by going to court you can ensure you’re paid as agreed for your existing work, but there’s nothing to stop the main contractor never using you again.

But while the practice may be seen as unethical, isn’t it fair that subcontractors bear their share of the pain everyone is feeling? John Quigley, managing director of Europa Technical Services, says his company was simply trying to protect its position in a difficult environment. The letter was sent only to suppliers whose contracts are up for renewal in December, and there is no suggestion it represents a breach of contract.

While Quigley admits the firm could have handled the situation more sensitively, he says that most of its suppliers responded positively to it, and that it is a mile away from the more aggressive practices of others. He says: “We are not forcibly renegotiating any services mid-term - only upon contract expiry. All we are asking from our key suppliers is to engage in a cost reduction discussion, a key part of which would be additional opportunities for them within the larger group.

“In the current environment, we need a long-term relationship with clients where we can offer innovation. But we also need our suppliers as much as they need us.”

In principle, many specialists agree: they say they accept the need to make savings, and that these can be best achieved by contractors working with them to cut out wasteful practices in the supply chain, rather than old-school subbie bashing.

The NSCC’s Nichol says: “We’re looking into it - this is really creeping up the agenda. From what we’ve learned already one thing seems obvious - demanding rebates is not a smart way of making savings, it’s not a sustainable way of making construction more efficient.” At the moment, that doesn’t seem to be stopping everyone.

Giant facilities management contractor Serco was forced last week to retract its request for rebates after being outed by a national Sunday paper, but Serco is far from alone. And while FM contractors have so far been responsible for most of this behaviour, after being squeezed themselves on government contracts, there is growing evidence that construction contractors have started doing the same.

According to the Specialist Engineering Contractors Group (SECG), the practices, which it says have developed over the past 12 months, take a number of different forms. In some cases contractors are demanding fees of as much as £10,000 up front in return for places on non-exclusive tender lists; in others, they are demanding rebates from firms that have already been given FM contracts. Worse still, some rebates are being applied retrospectively, for work already done at an agreed price. Prebates also take different forms, with preferred listing fees sometimes based upon the value of existing orders.

The SECG says some of its members have been told outright that they will get no more work if they don’t agree to changes in terms. It also alleges that the end client is often unaware of the practice, which means there is no guarantee that any saving is actually being passed on to the customer.

It’s not just the SECG that has noticed unsavoury practices. Suzannah Nichol, chief executive of the National Specialist Contractors Council (NSCC), says the organisation has had an influx of similar reports in recent months - from construction as well as FM contractors.

The practices seem to be more widespread among FM contractors, because of the long-term and repeat nature of the work. In addition, construction contractors have been excluded from the government’s cost saving programme, whereas FM contractors, such as Serco, have been hit hard.

Simon Tolson, senior partner at law firm Fenwick Elliott, says that if a main contractor unilaterally amends the terms of an existing contract it would be a simple breach of contract law.

However, that doesn’t necessarily mean it’s any easier to decide what to do: by going to court you can ensure you’re paid as agreed for your existing work, but there’s nothing to stop the main contractor never using you again.

But while the practice may be seen as unethical, isn’t it fair that subcontractors bear their share of the pain everyone is feeling? John Quigley, managing director of Europa Technical Services, says his company was simply trying to protect its position in a difficult environment. The letter was sent only to suppliers whose contracts are up for renewal in December, and there is no suggestion it represents a breach of contract.

While Quigley admits the firm could have handled the situation more sensitively, he says that most of its suppliers responded positively to it, and that it is a mile away from the more aggressive practices of others. He says: “We are not forcibly renegotiating any services mid-term - only upon contract expiry. All we are asking from our key suppliers is to engage in a cost reduction discussion, a key part of which would be additional opportunities for them within the larger group.

“In the current environment, we need a long-term relationship with clients where we can offer innovation. But we also need our suppliers as much as they need us.”

In principle, many specialists agree: they say they accept the need to make savings, and that these can best be achieved by contractors working with them to cut out wasteful practices in the supply chain, rather than old-school subbie bashing.

The NSCC’s Nichol says: “We’re looking into it - this is really creeping up the agenda. From what we’ve learned already one thing seems obvious - demanding rebates is not a smart way of making savings, it’s not a sustainable way of making construction more efficient.” At the moment, that doesn’t seem to be stopping everyone.

Supplier squeeze: The industry view

The main contractor

Stephen Ratcliffe, director, UK Contractors Group
In the current very difficult environment, main contractors are clearly going to want to talk to their supply chain about what can be done to reduce overall costs to the client.

The issue here is much more about the manner of the conversation and whether pressure is applied in an unacceptable way. Ideally contractors and suppliers should be able to have a conversation about how, as a team, they can work together in a more integrated way to find efficiencies.

The specialist contractor

Steve Bratt, group chief of the Electrical Contractors’ Association
Asking a firm to pay back a percentage of a contract won or lose the deal is nothing short of commercial blackmail. It is vital that this unethical practice does not become widespread.
For many SMEs across the construction sector subcontracting work is the lifeblood of their business. If rebates become commonplace it could severely damage cash-strapped businesses who have been hit hardest by the recession.

This practice could result in the tendering process becoming less about who can do the job best and more about who is willing to pay the rebates.

It is important that the new enterprise adviser, Lord Young, addresses this issue. If not nipped in the bud, it could snowball and do real damage to small businesses throughout the sector.

The lawyer

Simon Tolson, senior partner, construction, Fenwick Elliott
The actions most recently of Serco bring not only a sour taste but a smell of secret profiteering. Lawyers like me will shout it’s illegal unilaterally to reduce the value of extant contracts. It’s immoral, too. If someone pressures or conspires with others to interfere with your interests, then a claim based on one or more of the economic torts is open - of procuring a breach of contract, of intimidation and of unlawful interference.

There is no absolute test to establish how a threat may be fingered as “illegitimate”, but in general a threat of a breach of contract or other civil wrong will be ample. Evidential factors the courts will have regard to include: whether or not the claimant had a reasonable alternative; whether the threat was a grave one; and whether the claimant protested.

Recent case law, most notably Kolmar Group vs Traxpo Enterprises, illustrates that the courts expect companies to act properly in their commercial dealings, in spite of of any recessionary forces or other pressures, and will act to ensure that parties will not be able to rely on illegitimate threats and financial leverage to prop up margins.

The QS

Stuart Senior, managing partner, Gleeds
We have to bear in mind that the whole supply chain is reducing its costs, and the reductions in cost base are being driven from client organisations. So on the facilities management side, where there are more long-term arrangements, a lot of client organisations have gone back looking for reductions in costs - as the government has. On the capital side it’s different, a lot of this reduction is being driven at tender stage through the need to price things more competitively, where the lowest price is the highest priority key performance indicator at the moment.

Some contractors are bidding for work below cost, and then subsequently going back to the supply chain to see how the work can be delivered more cheaply. However, if people are going back demanding rebates on work already done, and I’m sure it goes on, it’s not acceptable. It’s the bullying aspect of the industry and it’s not healthy.