Is Procurement Responsible If Suppliers Are Stupid and Bid Too Low?

A frequent topic this week around the Carillion troubles has been whether government buyers have in some sense been wrong to "accept the lowest bid" when in some cases that may have led to Carillion accepting contracts that turned out to be unprofitable. It would be interesting to see how a policy of NOT accepting the lowest bid would actually work (!) but this reminds me of a story that we can probably tell now, as a good ten years have passed since these events.

A friend of mine was working as CPO for a large financial services organisation in the mid ‘noughties’.  As you might expect, telecommunication services is one of the very largest and most strategically important spend categories in that environment. When I was leading procurement at NatWest just before the millennium, our largest single contract was with BT and it was one of the top three in profile.

My friend’s organisation went out to the market for a major telecom service contract, including managed services as well as the conventional telephone type services. I don’t know the value, but if it was a ten-year deal it would have been many hundreds of millions, I suspect, perhaps even more. The deal was announced – and to no-one’s great surprise, BT Connect, at the time their corporate services division, won it.

But over a beer, this procurement director told me an interesting story. The formal tender process was followed, and that was “won” by another large telecom firm – not BT. Then at the last minute, BT came back to him with what he said was “a stupid offer, it was so low, we just couldn’t believe it”.  His firm accepted the offer, not surprisingly.

The other comment he made was this. “BT can’t possibly make any money on it, but that’s not our problem”. We’ll come back to that in a moment, but roll on a couple of years, and in 2009 BT announced huge losses in the services division, pushing the firm into a pre-tax loss of £134 million and wiping over a billion from shareholder value. Unprofitable contracts were blamed.

So during our discussion, my friend and I had a philosophical debate about whether it was in any sense  “our problem” as buyers if a supplier put in a stupidly low bid. At what point should procurement worry that an offer is too low? Does procurement have a moral or ethical obligation to stop firms getting themselves into trouble?

Our conclusion – after another beer – was no, we don’t. We must protect our own organisation, so we should think hard about the issues if, for instance, a firm was likely to go under because of the deal. Do we have contingency plans in place for that? (It’s rarely a positive for the buyer obviously if this happens to an important supplier).

And we should build protection into the contract to make sure the supplier can’t just walk away from the deal if it becomes too onerous – or at least, to ensure we are very well compensated if they do. But it is not our role to protect suppliers from their own stupidity, particularly if it is a large firm with many customers and financial strength itself. Indeed, our role is to drive competitive advantage, which often means we are paying less than our competitors for a similar product or service.

But how was it that my friend could see that this was a bad deal for BT, but the firm itself couldn’t? We can’t know, but there is every chance that the BT account manager for the financial services firm, his or her boss, and everyone up to the CEO of that division was heavily incentivised personally, based on growth and revenue. Profits always lag a year or two for big contracts of course, so they would probably all get their rewards pretty much immediately on doing the deal, and then worry later about how they could turn it into profitable business.

So is this story an indicator of what might have happened to Carillion, who have run into major problems, as we reported here? Did they take on contracts at unsustainable prices? Or is it an operational failure – in other words, it should have been possible to deliver the work  profitably, but poor Carillion performance meant that revenues did not come in as they should, leading to cash flow issues?

Whatever it is, we know that even the largest firms do stupid things from time to time. It is not the role of procurement to stop our suppliers doing that, if it benefits us. But good risk management means we should also bear in mind what it might mean if and when things do go wrong.

Voices (5)

  1. John Jones:

    Over time the true course of events in respect of Carillion will out – of, so say the X-files.

    I think too that Government has a role to play in “intelligent” procurement.

    You’ve touched on lowest cost bid (almost certainly) lowest cost and compliant bid.

    What do I mean by “intelligent” procurement – isn’t it supposed t be intelligent in the first instance?

    So, a necessary condition of intelligent procurement is knowing what you’re going to buy .- not always the case in the case of complex IT programmes granted – so, why buy it?

    A sufficient condition of intelligent procurement is knowing that what you are buying is able to be delivered in a timely manner. This, I think, might apply to Carillion , and, indeed, other large players.

    Essentially, we live in quite a competitive market for services in the UK – strikes me that a number of companies like Carillion also bid for work in other countries with , shall we say, less formal and/or scrupulous methods of procurement – I could easily forsee a local commercial director at a local bidding company “taking a punt” for a juicy contract – it’s the CFO of the parent company that needs to be accountable for corporate exposure – equally, when buying large infrastructure projects, it’s the governments job, to act in an intelligent manner (let’s call it an intelligent customer function) to ensure that it is not exposed to company’s greed and over exposure in other countries – years ago, the old OGC (now CCS) used to look at corporate exposure and indeed, industrial capacity to deliver UK government programmes.

    Let’s see how CCS comes out of the subsequent Carillion debacle/ investigation – what’s the point of Crown Reps if they are not doing their job?

    Summary – we’ve got Intelligent Suppliers – we also need Intelligent Buyers too.

    1. The Lady Doth Protest:

      How are Crown Reps targeted? How do their masters know they are successful? And what powers do they have – even if they know there’s a problem at a supplier, just what can they do about it?

  2. Mark Lainchbury:

    Its a little more complex than just price.

    Let’s not lose sight of what really caused their demise
    £200million witheld payment/bad debt in Quatar,
    delayed groudworks on aberdeen bypass fixed price jointventure with substantial delay penalties,
    sandwell & liverpool hospitals –
    some of the problems could/should have been forseen, others not.

    An Increasing drive to minimise risk allowances leading to lower bid prices.

    If you guess for your bill of quants that you can’t work 15 days in winter, another company will reckon on 10 days.

    A review by KPMG had found common issues on some problematic PPP contracts.

    It said: “These include accepting tenders with a high degree of uncertainty around key assumptions, undertaking contracts where success has been contingent on the performance of others not under our control and agreeing design changes without agreeing incremental costs and value.”

    Almost reads like a Ponzi scheme based on getting new contracts

  3. bitter and twisted:

    Could BTs low bid have made sense as a spoiler? Better to lose money than let an up and coming rival get a prestige client.

  4. Charlie Middleton:

    Think the final para is the most salient here – it is not the buyer’s problem if the supplier agrees an unsustainable price, but it may become their problem if the supplier can’t deliver and especially if they go bust. And even more the case where the contract is huge and half finished. In the public sector (where lots of Carillion’s work was) there are obligations for the contracting authority to require tenderers to explain the price or costs proposed where tenders appear to be abnormally low (Public Contracts Regs 69(1)), although the extent to which public sector buyers are capable of working out whether a deal is abnormally low is questionable.

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