Infrastructure – is the price of low cost too high?

April 2018 | SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2018 Issue

The need for investment in the UK’s infrastructure is universally accepted, with the means of funding the investment in these cash-straitened times hotly debated in political circles. The National Infrastructure Commission (NIC) published its first Annual Monitoring Report on 16 February, and calls for “marked improvement” in the UK’s transport and energy systems, digital capabilities and mobile coverage.

Investing in infrastructure ticks the box on several fronts: new schools and hospitals can be constructed to be energy efficient and to aid modern ways of working, saving on lifecycle costs in the long term. It is well established that new school buildings aid educational attainment and new hospitals assist staff morale. New roads and railways reduce travel time and investment in digital infrastructure is essential for business. In the words of NIC, new infrastructure is “imperative for economic success and for our quality of life”.

In the vast majority of cases, infrastructure is procured by the public sector, and therefore subject to competitive tendering. The theory behind competitive tendering is all positive. It gives organisations an opportunity to bid for work in an open and transparent manner. By advertising the opportunities, more tenderers will participate and with more competition, lower prices will follow. That assumes low prices are always good value for the taxpayer. But is that always the case? As the recent headlines associated with the demise of Carillion demonstrate, the ripples from low pricing can affect employees, subcontractors, investors, bond holders, banks and suppliers when things go wrong. Should we be asking whether procurement has gone too far and the price of low cost is simply too high?

Why do contractors and suppliers bid low anyway? The construction industry in particular is highly sensitive to fluctuations both in confidence and economic variables such as interest rates and exchange rates. Large construction contractors have significant overheads and need to keep their teams busy between jobs. During times of austerity or uncertainty, there may not be the deal flow or pipeline to allow contractors to efficiently manage their workforce. If they do not fill the pipeline, they risk losing their skilled workforce and their supply chain, both of which they need to deliver the next job competitively and efficiently. In an ideal world, a steady business climate coupled with a steady pipeline of projects would help to mitigate against pricing simply to cover overheads.

The cost of tendering for infrastructure projects is not insignificant and can easily be into seven figures. Tender costs mean businesses have to be selective about the deals they bid for, and if they bid and lose, the costs of the unsuccessful bid are borne by the business and the pressure increases to bid low to win the next deal.

Every day we hear about sustainability in the context of the environment, sustainable living and the need for sustainable economic growth. As part of the latter, we should consider sustainable business, recognising the contribution it makes to sustainable economic growth as well as the benefits that a steady sustainable pipeline of projects can bring to procuring authorities, contractors, employees, investors and users of infrastructure.

So what role can procurement play in encouraging sustainable business? In Scotland, the Procurement Reform (Scotland) Act 2014 introduced a “sustainable procurement duty” on procuring bodies. Before carrying out a procurement, the procuring authority has to consider how in carrying out the competitive tendering process it can “improve the economic, social and environmental well-being of the authority’s area”. To date, this duty has mostly focused on community benefits obligations, securing apprenticeships, on the job training and the like and it remains to be seen whether this duty can be used to help secure sustainable business. Should a similar sustainable procurement duty apply at a national level?

The procuring authority has to include in the tender documents the criteria by which bids will be evaluated. Large scale infrastructure projects procured by the public sector are virtually always evaluated and awarded on a combination of quality and price. At first glance, this appears to avoid the conundrum of low price winning at all costs, but in practice a tender with a 60:40 quality to price ratio can result in the lowest priced bid scoring significantly higher than other bids. Put simply, if the cost is low enough, the quality will rarely tip the balance sufficiently.

Setting evaluation criteria can involve a bit of crystal ball gazing. The evaluation criteria are set out the outset of the tender process and at that point, procuring authorities do not know what response they will get. The Public Contracts Regulations 2015 (and equivalent regulations in Scotland) allow procuring authorities to consult the market pre-procurement and use the information in planning the procurement, provided of course that the consultation with the market is transparent and non-discriminatory. Informed by the outputs from market consultation, procuring bodies can draft the tender evaluation criteria so that those areas where it really wants quality are most heavily weighted. It could be that certain tender questions can be scored as pass/fail, freeing up more points to be awarded against key areas, tipping the scales a bit more in the direction of the required quality.

Time spent by authorities in pre-procurement planning and strategy is never wasted. All too often, procurement programmes are drawn up with the first key date being the date the procurement is advertised for tender. With infrastructure being the political football it is, if there are delays in ascertaining how a project is to be funded, the date of advertisement (or call for competition) is less likely to be changed than many other key dates in the procurement timetable, so the vital pre-procurement planning and strategy period is often reduced. In its Annual Monitoring Report, NIC identifies that the government’s call for an independent review of funding and financing of Crossrail 2 risks delaying the programme from the originally proposed opening of 2033. The squeeze on the procurement programme begins and inevitably the pre-procurement planning phase will be shortened, leaving less time for careful consideration and fine tuning of evaluation criteria and price quality ratios to ensure quality is the winning element.

Infrastructure procurement and delivery cycles are substantially longer than political cycles and the desire for political gain pre-election can result in an announcement of large scale infrastructure programmes over relatively short periods after years of delay. This double whammy of inconsistent pipeline and then a squeeze on programme to fit with a political timetable can lead to less than ideal outturns for both procuring authority and contractor or supplier.

Taking low cost to an extreme, what happens if a procuring authority believes that a tender is mispriced? It has an obligation to investigate “abnormally low tenders” although there is no definition in the legislation as to the point at which a tender is to be considered abnormally low. Having called for and received a response in relation to the reasons for the particular pricing, there is no duty to reject the tender. It is more a question of common sense, rather than procurement law, in that if an authority believes it is not a sustainable bid then it should not be accepted.

There is an argument that if contractors and suppliers bid low prices that is their choice – in a dog eat dog world they must live with the consequence. The flip side of that position has to be that if the private sector makes a profit from infrastructure it should not be pilloried for doing so. As always, it is a question of balance. The scales have tipped a little too far toward low cost and if it is not adjusted, we will all pay the price.

Ailsa Ritchie is a partner at CMS Cameron McKenna Nabarro Olswang LLP. She can be contacted on +44 (0)141 304 6104 or by email: ailsa.ritchie@cms-cmno.com.

© Financier Worldwide

Ailsa Ritchie

CMS Cameron McKenna Nabarro Olswang LLP

Infrastructure & project finance