A Carillion Surprise
Why were so many people close to the Carillion failure so surprised? Didn’t anyone see it coming? Bonuses and dividends were paid right up to the end so it apparently didn’t look that bad to some. Did it happen that suddenly? Financial distress does not and cannot happen that fast. Losses that big come from performance that has been deteriorating over years.
Was it knowable and who could have known? The common elements of construction business failure have been clearly defined and widely known for 30 years so a failure of this size was definitely predictable much earlier. Each of these elements is identifiable, avoidable and take place during profitable years. That means the causes began to occur a long time ago.
The Magnitude of the Problem
Carillion had annual sales of about $7 billion with debt reported at $1.2 to $1.8 billion and forecast losses exceeding $1.4 billion. They also withheld subcontractors’ pay for 120 days, and owed vendors $1.1 billion, according to the Building Engineering Services Association. That would make total debt $2.3 to $2.9 billion or an astounding 33 to 40% of sales. And this does not include enormous pension debt reported to exceed $1 billion. If so, worst case debt exceeds $3.9 billion or more than half of last year’s sales.
This did not happen in 2017 as some suggest. For that to occur Corillion would have had to spend a dollar fifty for every dollar they took in. SOMEONE WOULD HAVE NOTICED. My experience suggests the problems began at least five years prior and probably longer.
The common elements of contractor failure, published three decades ago are:
- Changes in size of project
- Changes in geographic area
- Changes in type of work
- Changes in key personnel
- Changes in managerial maturity (the strengths and skill sets of top management)
Clearly the first four are identifiable–even obvious. Managerial maturity is little more difficult to recognize because it needs to be identified by the very people who suffer from it and it is never obvious to them. Middle managers see it, but are hesitant to say anything. Board members and credit grantors may see it, but many are too close to evaluate or may have competing interests and think it is not their place to interject.
Apparently no one at Carillion in a position to do anything about it understood the elements because: If you know the causes you don’t do them. If you determined to do one or more of them, you would be very careful and on high alert for any underperformance. You would also know that underperformance is what the elements are known to trigger. So some people should have seen it coming. My experience suggests that many did, but were not in a position to do anything about it. Who saw it coming? Middle management always knows what is going on and many would have suspected something was wrong. Some probably said something to their managers which is seldom well-received.
Clearly Corillion has been engaged for some time in the first four elements of contractor failure. During their growth they experienced:
- Growth in size of projects
- Entered new geographic markets
- Took dissimilar projects and entered into huge, long-term non-construction government service contracts
- Added numerous new, and untested employees resulting in a change in key personnel by dilution of their existing pool of key people
Engaging in the first four element of business failure resulted in huge losses that top management was either not aware of; did not understand the seriousness of; or chose to ignore or disbelieve the numbers. This is an exact description of the fifth element of contractor failure: A change in, or lack of, managerial maturity.
Why Businesses fail
When business failures occur there is a tendency to identify outside elements or events to blame. However, the involvement in the resolution of hundreds of construction business failures taught us that the five common elements (causes of failure) are internal. They are:
- Identifiable (not outside events)
- Avoidable (voluntarily [deliberately] entered into)
- Take place during profitable years (while things are going well new and inappropriate activities are introduced that result in future losses)
There was some hope that the discovery and announcement of the common elements would have some influence on reducing construction industry failures. Apparently some construction professionals don’t know about the elements, don’t believe them or don’t accept the elements as dangerous. It has been suggested that even for some who know the elements, over-confidence may cloud judgement with the belief that “It can’t happen to me.” or “We are too big to fail.” If it can happen to the biggest and the best, perhaps more construction professionals will heed the warning and elevate their respect for the risks defined by the common elements and avoid them.