Gain and pain: the sting in the tail of Darling's Budget

Alistair Darling’s Budget may have been delivered on the lower slopes of a £1.2 trillion mountain of public debt, but his approach to public spending for the next two years was, on the face of it, clear: “You can grow your way out of recession,” the chancellor said, “you cannot cut your way out.”

Well, that may be true, but the signs are that, with borrowing set to soar to £175bn this year, the government is going to have to rein in costs sooner rather than later – and it looks like construction spending is one of the first targets in its sights.

The picture is much bleaker than it was when last November’s pre-Budget statement was made, when Darling announced his intention to bring forward £3bn from the 2010/11 financial year as a kind of bridging loan to the construction industry. The Treasury has increased its estimate of the structural deficit by £35bn since then.

The Budget did contain some nuggets of good news: £300m for the further education college programme, a £600m housing fund and £405m for energy-efficient buildings. The really significant news, though, was the government’s plans for spending reductions.

The plan is to save £18bn a year by 2013-14 from cuts in capital investment and other state spending. About £9bn of that is to come from efficiency savings. What this means for construction was made clear in a report from the Treasury, published last week: it is to deliver £1.46bn a year of those efficiency savings on public sector projects (although, confusingly, this is by 2011/12).

What the government means by “efficiency savings” is well known to those in the industry who read government reports: smart procurement, frameworks, collaborative working, better exploitation of IT, off-site fabrication and so on. In theory, the industry and its clients would make savings by adopting these principles and technologies, and of course there would be the added bonus of a secure long-term workload.

In practice, many are sceptical that they can deliver the savings the government needs within three years – after all most of these ideas have been around for the past 10. And many are cynical about the temptations that clients face in what is turning into a fairly savage buyer’s market. Already there is evidence that departments, councils and agencies are finding other ways to exploit their suppliers’ desperation – including the use of fee cuts, retendered frameworks and “out-of-framework” one-off bids.

Cutting costs …

The Treasury’s Operational Efficiency Report, published the day before the Budget, announced that construction would be brought into its collaborative working programme, which has previously focused on areas such as IT and professional services.

The Treasury wants public sector clients to save £1.46bn a year by 2011/12 by improving the efficiency of their procurement.

The key to this is rationalising a client base made up of a disjointed mass of 44,000 public sector buyers, including 20,000 schools, 500 NHS Trusts and 355 local authorities on top of Whitehall departments, government agencies and quangos.

One way the government wants to do this is by making more use of professional buying organisations, such as the OGC’s Buying Solutions, which operates frameworks across different sectors. At the moment, only £12bn of the £89bn spent by the state on goods and services is bought through professional buying organisations. The government wants those organisations to be used for 80% of applicable Whitehall spending and 50% of the wider public sector by 2010/11. It also wants the 45 buying organisations, which were set up in an ad hoc fashion, to be reorganised to cover sectors and regions in a more logical way.

Another route to joined-up procurement is by integrating projects in different sectors, on the grounds that one large supply chain is cheaper to assemble than two smaller ones. Partnerships for Schools is combining schools and community health centres in its Local Education Partnerships, and it is intended that its £4bn national academies framework, currently being procured, will be used for a wider range of services than just schools.

We’ve saved an average of £75,000 a project. With 80 projects going on, that’s a saving of £6m, which is a couple of primary schools

Keith heard, south-east framework

Finally, the government is encouraging more councils to combine with their neighbours to develop “super frameworks”. The pioneer here is the South-east Framework, which is being co-ordinated by Hampshire council. This four-year deal was launched in July 2007 and its top tier, for projects worth more than £1m, contains 10 contractors working for up to 74 councils and 32 London boroughs. Keith Heard, its programme manager, says the framework has so far saved at least £12m.

He said: “It saves going through the Official Journal process, which costs an average of £75,000 for each project. With 80 projects going on, that’s a saving of £6m, which is a couple of primary schools. Conservatively, we’ve also added another £6m to our savings through early contractor involvement.”

Another region going down this route is north-west England, where there are plans to set up a construction hub of about 90 firms.

There is, of course, a catch. The use of frameworks to reduce preconstruction costs and encourage partnering may provide a more certain workload for contractors and long-term savings for clients, but there are doubts about whether they can achieve all of the government’s cuts by 2011/12.

This is partly owing to a lack of deadlines. John Lorimer, the capital programme director of Manchester council, is heading the North-west construction hub. He says the project has no fixed timeframe for its launch, although it hopes to make appointments this year, as the councils “want to be sure they get it right”. It published its first tender in March, but no date has been set for formal appointments.

Construction South-west, a framework being set up by Devon council, was closed in January but has no fixed timetable for the selection of bidders or for mobilisation of the project, according to its website.

… or cutting throats

Unfortunately, there is a quicker and easier way to deliver “efficiency savings”: fee cuts. Regardless of whether clients are using frameworks, experts say they will be tempted to take their cuts from the hides of their supply chains. This has already happened in the Republic of Ireland, where the government has ordered an 8% fee reduction on all services procured with public money with effect from 1 March.

The attractions of this route are likely to be compounded by the lack of procurement expertise in many public authorities, particularly among their lower echelons, for whom quick wins will outweigh the benefit of long-term partnering arrangements. As Michael Ankers, chief executive of the Construction Products Association, puts it: “The problem is many public sector clients are inexperienced. So the simple solution is just to cut prices.”

The worst-case scenario is provided by the the Irish government, some of whose cuts were retrospective, and by Tesco, which has imposed cuts of up to 50% on its consultants. Even more ominous is the success of that approach, which helped the supermarket to a £3.1bn profit.

It seems some public sector clients have begun taking a similar approach. A source at one contractor said his firm had recently been in talks over a university project in the south of England that was part-funded with public money. He was abruptly ordered to reduce his bid price by 10% if he wanted the deal signed. “We had little choice as we were on a one-to-one basis by then,” he said.

This project was procured outside a framework, which makes it easier to take advantage of contractors’ willingness to slash margins to preserve cash flow. This is already leading several authorities to go outside frameworks to procure large projects.

Peter Fordham, an associate with Davis Langdon, says: “There is increasing evidence that clients are beginning to procure large projects out of framework in order to secure price competition.” It is understood that this is happening most frequently in the traditionally cut-throat higher education and leisure sectors.

We’re seeing warning signs that councils have been given a cost-cutting directive and are trying to find ways of doing it

Andrew Oliver, Kier

And in the justice sector. As Building was going to press news broke that the five 1,500-place prisons that are to replace the Titan jails will be procured outside the government’s prison framework, which includes Wates, Willmott Dixon and Kier.

Keith Heard of the South-east Construction Framework admits that “there has been a slowdown of projects being procured through the framework” since the recession began, although he says it “is likely to be largely because there isn’t the work around”. However, it is understood that at least one council recently went outside its framework on an education project.

Several public sector clients have been trying to cut prices within their frameworks. John Frankiewicz, chief executive of Willmott Dixon, said: “In the housing sector in particular we’re aware of clients selecting from the framework list on the basis of lowest cost. We’re fearful that some frameworks will start to be used as selective tender lists, with the client always going for the lowest price.”

He added that on frameworks “where the client is more mature”, it has carried out a market test and used the results to get contractors to lower their prices. However, he said his main worry was whether future frameworks would be let on the basis of lowest costs, which would return us to the evil days of “foot-in-the door” contracting, whereby a firm takes work at zero margins or less, then makes its profit once the job starts, by piling on charges at the merest hint of a variation. “It’s less likely on frameworks than on one-off bids, but it could still happen.”

Another tactic employed by public clients is to stop refunding some of the costs of contractors who work with them at preconstruction stage. A director at one contractor, who did not wish to be named, said: “This is the most common change we’ve seen so far. Previously, if you’d been doing preconstruction for, say, 12 months they were allowed to pay you some of the costs you incurred. Now more often those costs are being questioned. We’re seeing warning signs that councils have been given a cost-cutting directive and are trying to find ways of doing it.”

The premature slowdown

Given the state of the public finances, there is much concern about the prospects for public spending after 2011. Worryingly, however, the Budget indicates that the slowdown is likely to come earlier than that, in the form of reprocurement and “reprioritisation” programmes.

So even where frameworks are in place, the smallprint in the Budget suggests they should be retendered to take account of changes in the law of supply and demand, which means that firms that have counted on an order book for the entire duration of a contract may be disappointed.

The Budget picks out the following schemes:

• The Highways Agency’s maintenance contracts are to be re-tendered to save £140m.
• The Home Office is to achieve £60m in savings from “improved commercial activity including a review of major programmes”.
• The communities department is to save £400m by “reprioritisation and rephasing” its construction programmes. Its Regeneration Framework, to be published shortly, will “reprioritise regeneration investment”, which many suspect to be a euphemism for delays.
• The Department for Environment and Rural Affairs is to save £6m by reprocuring its facilities management services.

Meanwhile, the Ministry of Justice has confirmed that it is to cut 10-20% off the cost of its building programme, a policy that has led to delays at new-build prisons at Maghull in Merseyside, and Belmarsh in south London (worth a total of £600m) and a £150m jail at Featherstone near Wolverhampton.

The Budget also alludes to a slowdown in schemes procured by the universities department. The £300m of extra money referred to earlier was intended to restart projects college worth £750m that were part of the Learning and Skills Council’s renewal programme; however, this leaves a £6.25bn pipeline of work in limbo.

A source close to the department confirmed that any further education projects going forward were likely to be rescheduled and downscaled: “When you look at the Budget, everything in there is about efficiency.”

Well, efficiency savings are by definition a good thing; if construction does adopt the latest prefabrication methods and the latest IT systems for design and business processes, all will benefit. It could even lead to a transformation of the industry. But if the government claws its money back using a combination of brute force and ignorance, the danger is that it could lead to dumbed-down procurement, adversarial contracting and an industry that is a great deal less productive.

Original print headline - The gain and the pain