Wining contracts: Confidence trick

You get what you pay for - and there appears to be a dawning realisation in the public sector that choosing the lowest bid can lead to big trouble.

The rapid demise of Jarvis, Rok and Connaught in the quoted sector and a near-continuous litany of failures of well-known unquoted companies such as Kinetics, are putting justifiably parsimonious public sector clients on their guard. And private sector clients are also becoming aware that the cheapest tender does not necessarily equate to the cheapest outturn cost. Two recent tales serve to illustrate this caution.

In one case, a cash-rich large contractor came third in the running for a public authority contract worth high single-digit millions. Its bid was several percent above the leading one, from a markedly smaller firm. But in a sign of the dog-eat-dog world into which the industry could be descending, the large contractor suggested the client ran a basic solvency test on the winning bidder’s latest filed accounts.

Having a contractor go bust will create a longer-lasting stink in local newspapers than the electorate twigging that the council could have saved a few percent

This test employed standard accounting measures such as “creditor days” (trade creditors on the balance sheet divided by cost of sales on the profit and loss account, times by 365 days). It is a method for gauging how long it takes firms to pay their bills. It is a theoretical tool and should be used with other accounting measures. Should a firm be judged wanting on this measure, it does not mean it is on the rocks. But my hunch is the calculation will become a ready reckoner that subcontractors will increasingly turn to when scrutinising which main contractors they feel confident enough to work for.

The outcome in this case was that the client did its sums - and switched to the large, third-placed contestant.

This appears to fly in the face of at least the spirit of EU Official Journal rules, which are intended to ensure they chose the best value bid and require public authorities to advertise all work across the community. But it seems UK local and central government authorities are using increasingly broad interpretations of the rules.

The reasons for caution are clear. Having a contractor go bust on a leisure centre, school or whatever will create a longer-lasting stink in the Droitwich Shopper or equivalent local newspapers than the electorate twigging that the council could have saved a few percent.

The second story, this time in the private sector, reverses the David and Goliath relationship. This was for a much larger project. A top UK contractor was chosen to do early works and appeared to have a very low basic bid but, according to those close to the project, the contract was open ended on the subject of variations. The client chose to switch to a much smaller contractor, which it had not worked with before. At the launch reception the client could not have been more glowing in his praise of what looked to be a magnificently executed project. Client and contractor are discussing follow-on work.

Big or small, the keys to companies’ survival in an increasing brutal market are becoming balance sheet strength and reputation

These and other tales depict a widening gulf between the haves and have nots. Big or small the keys to winning work in an increasing brutal market are becoming balance sheet strength and reputation. An ill-judged tender can blow both almost overnight: cost over-runs and payment disputes spill down to the supply chain, leading to delays, bad headlines and difficulty obtaining bonding. The temptation is to take on lower priced and risky work to generate cash to put off the inevitable.

A natural conclusion would seem further consolidation. Good firms struggling against near-suicidal competition may choose sanctuary with a stronger group, such as ground engineer Roger Bullivant, which is being acquired by French giant Vinci after its turnover halved. It seems likely there will be further mergers, especially involving firms that have strong technical niches, regional positions or client relationships.

Top firms, especially those with net cash positions such as Balfour Beatty and Kier, have demonstrated solid order books in recent statements despite declining markets. But firms not in this position are likely to take a double hit. The last recession suggested that the upturn hit them even harder than the downturn when badly treated subbies raised prices before main contractors could pass them onto clients.

It looks likely that clients will increase their scrutiny of the financial health of their suppliers. With the possible result of pushing many further towards the brink.

Alastair Stewart is a construction analyst at UniCredit Research