Civil servants have disappointing news for their political masters about the number of hospitals valued at £150m and upwards that can be delivered ahead of the next election. Meanwhile the Department for Education and Skills is preparing to flood the market with so much work that it is bound to overheat a construction economy that is already inflating at four times the rate of the Retail Prices Index. Huge construction projects at Heathrow Terminal 5 and Crossrail, as well as Prescott’s massive housebuilding programme, will put even greater pressure on the limited resources of UK construction.
In short, it seems almost certain that contractors will not be able to deliver the government’s current plans, particularly in the vital areas of health and education.
Ailing conditions: The health sector
Most political pundits reckon that Blair’s attempt to win a third general election is just a year away. Having staked so much of the government’s reputation on public service reform, ministers are thought to be looking for a big push on hospital proposals. If so, they will be disappointed. DoH civil servants only plan to invite bids for five or six major hospital projects in the next 12 months – about half the number ministers are hoping for. As one Whitehall source puts it: “Politicians see timeframes differently. Most ministers would like to see targets delivered more quickly.”
But the market simply does not have the wherewithal to bid for more than half-a-dozen schemes. Only the largest contractors with vast financial and manpower resources can undertake the complex and costly bids required for a big hospitals, but even they can only take on so many projects at once. “Is there a capacity problem? Yes, there could be, but it depends on when the projects come out. If everything comes out at once then there could be a problem,” says Ian Rylatt, managing director at Balfour Beatty Capital Projects.
The problem of timing has been borne out by the £340m Vanguard Health Project, a hospital scheme in Plymouth. The client trust was due to invite expressions of interest last year. The problem was that its market research indicated that an advertisement in the Official Journal was unlikely to elicit a single bid – and under new DoH rules at least two are necessary to ensure competition.
Peggie Johnson, the service development co-ordinator for the Vanguard Project, says: “We wanted to make sure that we had firm market interest. There was no point going out when the market appeared to have reached saturation point.”
Plymouth authorities now hope to get the project out to the market in June, when the industry is less busy, although some DoH sources believe that even this target might be slightly ambitious. Plymouth is in Cornwall, which is beyond the scope of most major contractors’ offices; this makes it an awkward scheme to bid for, as it places further strains on employees’ time.
Another monster scheme that has had its problems is the £620m St Bartholomew’s and Royal London hospitals project, which went to the market in 2002. The bidding costs for the scheme, estimated to be between £20m and £30m, put contractors off competing. At one stage Skanska looked sure to be the only bidder, and the DoH even considered allowing the Swedish contractor to run a one-horse race against the public sector comparator – a device used by departments to evaluate value for money on PFI schemes. As it was, one other bidding team emerged, led by French giant Bouygues. The DoH still had to change its own rules, which require a minimum of three bidders for a hospital.
Skanska ultimately won the project, but some advisers believed that Bouygues should have been given the nod.
The difference between the bids was thought to be somewhere in the region of £5m, with both proposals being otherwise similar. One adviser said that selecting Bouygues would have been more advantageous to the PFI sector, as it would have brought in a large and relatively fresh player into the market. He said: “Wouldn’t risk have been managed better, given the negligible difference between the bids, had the department given the deal to Bouygues? Skanska already had a backlog of work. Selecting Bouygues may not have been economically advantageous to the deal, but it would have been to the country.”
Certainly, the loss had a major impact on one of Bouygues’ architects, HLM Design. As one of the few healthcare design experts, HLM was always heavily exposed to the market. Losing major projects inevitably had a harsh impact on the practice – the Bart’s loss was one of the reasons it had to be rescued from administrative receivership through a management buyout last month. As a result, chairman Chris Liddle has vowed to broaden the focus of the practice away from the PFI, the main procurement route of hospital projects. This effectively removes one major healthcare
design expert from the game and will make it even harder for future bidders to put together a consortium.
Liddle says: “The costs of submitting for a major PFI for all concerned have risen dramatically since the mid 1990s
when we first engaged, and I think all the professions
in the construction industry have got to carefully examine these costs.”
Bidding costs for consultants have typically increased 50% on PFI projects over the past decade. A £100m project would have cost an architect about £300,000 in the mid 1990s – even then a heavy burden on their relatively fragile balance sheets – but this has risen to the £500,000 range.
Skanska already had a backlog of work. Selecting Bouygues for St Bart’s may not have been economically advantageous to the deal, but it would have been to the country
A pfi adviser on the harsh choices facing government
The bidding pressure is even harsher for the contractor, as shown by the Bart’s example. Some overseas contractors have started to come forward: Australian Multiplex and Spanish-owned Amey are bidding for the Peterborough Hospitals project. But overseas interest is largely limited to those few companies that want to learn about the PFI market, which is fairly mature in the UK but in its infancy elsewhere.
The desperation for foreign bidders has led the DoH to talk to US giant Halliburton about the possibility of its subsidiary, Kellogg Brown & Root, entering the UK health market. Halliburton is hardly an ideal choice – once headed up by US vice-president Dick Cheney, it is currently the subject of a criminal investigation in the USA after claims it overcharged for transporting oil for Iraq. Not that it will be easy to persuade Halliburton to become a regular player. Its skills only lend itself to bidding for hospitals valued at more than £500m; such projects only come out a few times a decade. Besides, many overseas bidders find it difficult to get excited about the UK market as profit margins are about 3% lower than in the rest of Europe.
So it seems that Blair had better not rely on the DoH to maintain Labour’s political hegemony.
Tough lessons: The schools market
“Education, education and education” were Blair’s three top priorities when he first took office. By this, he meant more teachers and fewer children in a class. Now it means shiny new schools – or at least, ones that are less dank and grotty.
PPP quango Partnerships UK is jointly overseeing the incoming building schools for the future (BSF) programme with the Department for Education and Skills. James Stewart, Partnerships UK’s chief executive, believes that the 15-year, £60bn project will stimulate enough interest from the construction sector, but concedes: “There are two points here: will demand match supply? Also, there is the issue of maximising efficiencies on the supply side.”
These efficiencies include reducing bid costs and not heating the construction economy to the point that it seizes up. The department believes that it will create greater competition by structuring the projects in such a way that small and medium-sized contractors will be encouraged to bid. For example, although several schools would be batched together on most projects to make bidding worthwhile to major contractors, more design-and-build contracts would bring in regional contractors who do not have a facilities management capability.
However, the problem for most contractors interested in the forthcoming programme is that it is unclear how procurement will work. Some projects will be heavily batched using the LIFT joint-venture procurement method for smaller projects, others might use the PFI model, and some may even use a mixture of the two. The flexibility makes sense given the diversity of the 3780 schools earmarked for work, particularly as the projects will involve a mixture of rebuild and refurbishment.
Firms considering entering the market are naturally reluctant to put themselves at the bleeding edge of the programme, and the first schemes could well have few bidders. For example, outsourcing specialist Mapeley was planning to bid for a schools project in Kent earlier this year. The idea was to dip its toes in the education market in preparation for the BSF programme. However, it pulled out after deciding that it could learn nothing from the scheme if BSF evolved in a way that was irrelevant to current capital education projects.
The government might believe that the country desperately needs these new schools, but it is not willing to carry through the programme at any cost. Peter Stanton-Ife, BSF director at the DfES, says: “It would be counterproductive to launch a scheme in say, Liverpool, where a lot of work is already being undertaken and construction inflation is racing ahead.”
A source close to the BSF programme expanded on this theme, pointing out that even if an area was desperate for a schools revamp it would still be subject to a value-for-money test. Therefore, if it added to construction inflation, the scheme would not take place. The lack of capacity that leads to inflated construction prices could therefore rule out some vital education projects.
Where have all the bidders gone?
There is no overarching body in charge of the capacity issue in government. Sir Peter Gershon’s efficiency review of government, taking place this summer, should partially address this problem, but for the moment departments effectively compete for bidders. Many in the construction sector believe that a cross-governmental unit should be set up to match up market appetite with project supply: “It is nobody’s problem at the moment, but it is a problem that is out there,” says one government adviser.
Heathrow Terminal 5 and the likely governmental go-ahead for Crossrail are further squeezing the construction sector’s capacity. Government departments have to make their projects as attractive as possible to bidders. The DoH is known to have some concerns that the schools programme could take away potential bidders for some of its schemes. By bundling together schools, some education projects could be worth as much as £300m, providing the necessary returns to attract companies who might otherwise pitch for the large hospital schemes. A DoH source confirms that it will discuss this problem with the Treasury over the summer in a veiled effort to manage the market better.
Robert Osborne, who until recently headed up the BSF programme for Partnerships UK, says: “The government has got a question to answer, which is how do they not lose control of pricing if departments are competing?”
If the government has no overall body setting limits on the amount of work coming into the marketplace, it cannot ensure that one department does not offer too many schemes, particularly in the costly PPP arena. As companies now seek to win at least one in three PPP projects, they have become highly selective in what they bid for. A deluge of schemes on the market at any one time will dilute the number of bidders for a given scheme, raising prices as a result of lack of competition. As KPMG PPP director Tim Stone puts it: “All the experienced bid teams in bidding groups such as contractors are extremely busy and can only take on so many projects.”
Equally, in a bid to raise interest in their schemes over their rivals, civil servants look to offer the most attractive terms possible – also potentially raising costs. One civil servant told Building that it was a specific ambition to make education projects more attractive than health projects.