Carillion collapse means little guys lose out again
With hundreds of millions owed to subcontractors, the consultation on late payment is timely.
Until Carillion entered liquidation last month, the big focus in 2018 apart from Grenfell was likely to be on productivity. The issue of productivity has been a constant refrain from the Treasury in recent years, and the need to improve it, particularly in the SME sector, does vex the government.
But for the many thousands of SMEs who worked for Carillion, productivity is likely to be the last thing on their minds at present. They will be thinking mainly about survival.
In the construction industry there is a paradox. Low margins don’t necessarily equate to a low return on capital employed. Shareholders’ capital invested in construction is quite low because, by and large, construction operates using other people’s money, either through advanced payments from customers, late payments to subcontractors or that other little honeypot, retentions.
Carillion’s collapse has put late payments to suppliers in sharp focus. With hundreds of millions owed to subcontractors of what was the UK’s second biggest construction group, the effect on these mostly small companies is likely to be damaging. It is timely therefore that BEIS has been consulting the industry on changes to retention payments over the last three months.
Retentions, so the theory goes, are supposed to improve productivity although in practice that does not seem to be the case.
Of course the outcome of the consultation and hopefully the outlawing of retentions will come too late for many firms, including those who worked for Carillion. As the consultation estimates, £229m of retentions are lost each year to the supply chain through upstream insolvency.
With retentions being approximately 5% of contract value it does not take much to work out that it means profit is being lost on about £8bn of turnover, assuming a 3% margin.
The impact of protecting retentions and putting them out of reach of the current retention holders would increase the borrowing requirement of those using the money by an estimated £2.1bn. To be able to borrow £2.1bn extra, the industry needs considerably more equity than they have at the moment, perhaps an additional £10bn when you factor in the risk.
Having to put an additional £10bn into capital can drastically reduce the return on capital employed. So it is understandable to see the reluctance to give up retentions, because retentions are another form of cheap and profitable business finance.
Late or non-payment of retentions is common. Again as the consultation points out, many lower tier subcontractors eventually give up any expectation of receiving the retentions, be it through not wanting to alienate their customer, having to meet obligations on a non-connected contract, or through delay and procrastination tactics designed to wear them out.
The consequences can be devastating. The FMB in a recent survey reported that 5% of members have had to withhold paying wages due to late or non-payment. This is exploitation.
It’s no good those at the top saying wsmall firms obviously don’t have enough working capital in their business when it is clear it is being appropriated by those up the supply chain either through retentions or long payment terms.
In the current business model, it is the case that risk is shifted from those that should be taking and managing it to those that are powerless to do either.
During the months leading up to Carillion’s collapse, it is clear that those with clout, like the government clients, have done ok. Those with no clout – the long line of subcontractors – have ended up being the losers as usual.