16 Jul 2018
Outsourcing must be handled more responsibly, says LBS expert
The UK government has a unique responsibility to demonstrate the highest standards of procurement practice and responsible behaviour when outsourcing, according to Chris Higson, Associate Professor of Accounting Practice at London Business School:
“Government cannot hide behind caveat emptor [the buyer takes the risk] like just another player in the market.”
He pointed out that some SMEs (small and medium-sized enterprises) that may be bankrupted by Carillion’s demise say their confidence in subcontracting to Carillion came from the government being the ultimate customer.
“They have a justifiable complaint,” he said. “These small contractors do not have the resources to do full financial due diligence. When government gives a significant amount of work to a supplier, it effectively hangs a ‘By Appointment’ badge over that company’s front door. Government is negligent if it does not understand the significance of the signal it is sending.”
• Two lessons from the failure of Carillion
A highly critical report by the Commons public administration select committee found that Carillion’s collapse has exposed “fundamental flaws” in the government’s approach to contracting with companies for the provision of public services.
The report found that the government had forced contractors to take unacceptable levels of financial risk and has had to renegotiate more than £120m worth of contracts since the start of 2016 to ensure public services would continue.
“Companies have been sent a clear signal that cost, rather than quality of services, is the government’s consistent priority,” the report stated. It went on: "Contractors told us that the Government was known to prioritise cost over all other factors in procurements, driving prices down to below the cost of the services they were asking firms to provide.”
Sir Bernard Jenkin MP said: "It is staggering that the government has attempted to push risks that it does not understand onto contractors, and has so misunderstood its costs."
Chris Higson continued: “The UK government will continue to outsource, but it has a responsibility to do it properly and with great care.
“The company was probably an accident waiting to happen – its margins were too thin and it had a balance sheet that was too weak for the economic risks it was taking. But government kept giving contracts to Carillion. That vote of confidence increased the eventual damage to the shareholders, the banks, and any number of suppliers and employees that Carillion took down with it. And it transferred substantial wealth to the hedge funds that had been astutely short selling Carillion for several years.”
Carillion, which employed 19,000 staff in the UK at the time of its demise in January, had 420 public sector contracts. Its liquidation will cost UK taxpayers at least £148m, according to a report from the government’s auditor, of which an estimated £50m will be paid to PwC for its work in the process.