Rocky road
Carillion bears the burden of troubled Aberdeen project
The Aberdeen Western Peripheral Route was billed as a “major infrastructure project that will significantly improve travel in north east Scotland”. But, for Carillion at least, it has turned out to be a major headache that significantly hurt its finances.
The troubled firm was part of the consortium – with partners Balfour Beatty and Galliford Try – that was awarded the contract to build the road in December 2014.
At the time, the decision was widely welcomed by both the Scottish Government and the local council. There had been a long wait for the 36-mile (58km) route and the project was expected to provide thousands of jobs for local people, many of whom had suffered as the oil industry slowed.
However, at some point the scheme went wildly off course. Indeed, the road in Aberdeen typifies Carillion’s problems: a project that should have been relatively simple has been dogged by delays, pushing costs up and leaving the firm with a serious cashflow problem.
It is likely to be one of a handful of projects that contributed to the £845m write-down Carillion announced two weeks ago, along with two further UK projects and others in the Middle East and Canada.
At the heart of the matter lies a problem of procurement: why do contractors often get the prices and timescales on major projects so wrong? It all comes down to risk, and who is willing to take it, explains Richard Steer, chairman of construction consultancy Gleeds.
“Naturally the client wants to minimise their exposure to risk,” he says. “Contractors are the risk takers, which is where they can make their profits, but it can backfire.”
Companies are forced to bid for five or 10-year projects at a fixed cost, particularly when the client is a public sector body, he says.
“What’s been happening is that contractors have been pitching for jobs and they’ll put a price in. Then they start talking to subcontractors, and then the subcontractors come back with prices that are more expensive.”
He says that the current environment, where there is a shortage of labour, means costs have risen for subcontractors. It is also notoriously difficult to predict what the labour market or the cost of materials, such as steel, will be over the life of a project, meaning that a fixed cost at the start of a contract might seem wildly ambitious by the end. All this chips away at wafer-thin margins, which could be only 2pc to start with.
Others have suggested that the problem for Carillion and its peers lies in the subcontractors themselves. Over the years, companies have cut back on what is carried out in-house, meaning they have less control over the work being done.
In Aberdeen, Carillion, Balfour Beatty and Galliford Try tendered for subcontractors to do work including drainage, plant and equipment hire, earthworks, steel reinforcement and rock crushing, through contracts worth almost £200m.
“Contractors are increasingly really struggling to manage their business,” says Mark Farmer, who recently wrote a Government-commissioned report called Modernise or Die on improving construction efficiency.
“Although employing subcontractors helps businesses avoid a large payroll and keeps overheads down, it does have its downsides,” he says. “Many companies now want to have more control over who’s delivering the work, which means moving away from subcontractors.” Some might say that Carillion should have predicted the problems it would face in Aberdeen. The new road route had been on the cards for nine years before it was finally approved by ministers in 2012; by then, the cost of the scheme had swelled from an initial government estimate of between £295m and £395m, to £745m.
The consortium had to fight off three other groups in order to win the contract, amid fierce bidding and ministerial pressure to keep the cost of the project down.
Construction finally got under way in February 2015, with the road due to open later this year. But by November 2016 it became clear the target was not going to be met. The consortium had failed to carry out crucial work on the site before winter began, meaning they had to delay until the weather became warmer. More minor problems, including delays brought about by fears over pollution risks to nearby rivers, added weeks at a time to the project.
At the time, Keith Brown, the Scottish transport minister, told a worried public that the cost of the delays would be borne by the contractors, not by taxpayers.
“The contractor is only paid when the road is open. The only payments that we make in relation to the road being completed are those set out in the contract,” he told a meeting of the Scottish Government’s rural economy and connectivity committee. Amid concerns that many large public contracts are being put in private hands, politicians have been keen to spend as little public money as possible, ensuring that locals can see value in large projects.
But this means that contractors are often put in a difficult position, says Joe Brent, analyst at Liberum.
“The public perception is that these companies have been gouging out the eyes of government for ages, but it’s actually the other way round,” he says.
“They are often under pressure to take on contracts at very unattractive terms.”
It is not just Carillion that has suffered on the Aberdeen road project: two months ago, Galliford Try announced that it had been forced to set aside £98m to cover the costs of completing two major infrastructure jobs – one of which is thought to be the Aberdeen project and the other the Queensferry Crossing in Scotland.
Every time work is pushed back or they run into a problem, companies have to shell out more money for extra labour costs, extra materials, machine hire and a host of other costs.
What’s more, once they are in trouble, many companies do not own many assets, and so have difficulty raising money to bail themselves out. “There are other ways of procuring, such as two-stage tendering where more risks are transferred to the customer,” says Mr Brent.
Mr Steer agrees: “What should happen is clients should be more flexible in their approach in accepting and allocating risk,” he says. “It’s a fine line that they’re treading.”
What is clear is that there is a pinch point between the needs of the client and the contractor, which comes down to having to offer work at a competitive rate, while also making sure that the work can be carried out for the right cost.
The Scottish Government, through Mr Brown, has insisted that the Aberdeen road project will not be affected by Carillion’s recent woes and it is now scheduled to open next year. But for Carillion, the troublesome road is merely indicative. If it is to survive, it, along with many of its rivals, may have to completely rethink the way it does business.