The opening words of the 2016 Carillion annual report, signed by chairman Philip Green and published less than a year ago, run: ‘In 2016, we made good progress in a number of our markets, while managing and mitigating the effects of more difficult trading conditions in others. Importantly, the Board maintained its focus on overseeing and developing the Group’s strong governance and management framework, on scrutinising the Group’s performance, on assessing the Group’s risk management and control processes and on constructively challenging the Executive Directors’. The whole report is written in the same comforting vein, with soothing sections on risk, vision and values, and why investing in the company would be a good idea.
It’s easy to mock. But given that four months later the company issued a substantial profit warning and the CEO departed with instant effect, Green – formerly adviser to David Cameron on corporate responsibility, no less – was either in the dark about the real situation or being exceptionally parsimonious with the truth. And where were the auditors? It’s hard to know which is worse and where to start. Either way, it’s a brutal slap round the face for current governance practice, which has been singularly unable to head off, or even warn of, one more spectacular corporate disappearing act.
Why did Carillion evaporate so quickly? The answer is that it was really a shell company. As a fully financialised product of the neo-liberal political philosophy ‘that for years has elevated financial engineering above real engineering; off balance-sheet finance above paying for things openly; and lauded the private sector above the public sector’, as the Evening Standard’s Tony Hilton noted, it had nothing meaningful to sell.
It grew to be the UK’s second largest construction firm and a member of the FTSE 250 not organically but through a flurry of acquisitions of facilities management and other service companies including Mowlem, Alfred McAlpine, John Laing and a several others. But as with other other large outsourcers such as Serco, G4S, Capita and Atos (incidentally all equally reviled), its main expertise, such as it was, was not in operations – much of the messy real business was subcontracted – but in doing deals and managing outsourcing contracts. When that became harder to pull off, Carillion had no option but to up the stakes and add bigger construction contracts, such as £1.4bn of work for HS2, to keep the cash coming in and the bailiffs away from the door. Eventually, in the colourful phrase of Matthew Vincent in the FT, it had become ‘a sort of lawful Ponzi scheme’ in which new or expected revenues went straight out again to pay pressing current demands. Pay incentives may have played a part in this, bonuses in the industry frequently being tied to increasing revenues rather than profits. In its 2016 'Say on Pay' report, shareholder adviser Manifest noted important reserves about Carillion's remuneration policies, raising doubts about quantity, lack of 'forward-looking' and stretching targets, and the exemption of share-based awards from clawback provisions.
Carillion’s demise shows in sharp relief the real toxicity of most large public outsourcing deals, which might have been designed to be poor value for money for the public and encourage wrong behaviour by companies. Politicians think it’s a simple matter of pricing, but the real problem is design and the thinking they reflect. In effect, deals are constructed zero-sum games in which one party can only gain at the expense of the other. To some extent outsourcers are hoist with their own petard. Taking advantage of naive negotiators, they comprehensively won the opening rounds, getting themselves typically paid by volume (number of calls answered, appointments made, applications processed) rather than service improvement. They compensated for low opening bids by back-loading contracts and making changes subject to punitive cost penalties – in effect locking in existing high-cost, low-quality designs.
But this triggered an arms race which no party could win. To avoid accusations of waste, Whitehall slashed margins and drove ever harder (but not smarter) bargains. Operators responded by cutting costs, their own and those of their subcontractors, the burden of which fell heavily on labour – substantially contributing to the explosive growth of zero-hours and other exploitative contracts – and cutting corners. There is no incentive to understand demand and improve response to it. One branch of this path to destruction leads to Carillion, and the multiplying knock-on effects through the wider economy. Another ends at the burnt-out shell of Grenfell Towers. A third is the dismal overall state of public services, with low pay, low productivity and no innovation co-existing with gross inefficiencies.
Pace Jeremy Corbyn, it’s not outsourcing of itself that is to blame. It’s perfectly possible to devise positive partnerships rewarding innovation that pays off in services that are both better and cheaper. But not with present ideologically blocked thinking. As Hilton puts it: ‘The collapse of Carillion is an indictment of management, but one in which the government, Whitehall, City bankers and even investors are complicit’. It is yet another example of the UK’s unique penchant for ending up with lose-lose: pseudo-marketisation without any of the benefits on one side, intense but ineffective government involvement on the other. The biggest loser of all in the Carillion debacle is the rest of us.