Outsourcing and the services business model in construction

The construction industry in the UK has been through some turbulent times recently. The recovery from the impact of the 2008 downturn is not complete. The country voted to leave the EU and has created uncertainty for business development. The PFI and PFI 2 systems have been challenged and in some cases discredited. The privatisation of the railways and water sectors have not necessarily delivered the commercial outcomes for the construction industry.

However, one of the biggest issues has been the failure of the outsourcing/ services model within the construction industry. The services models were seen as a tonic for the perpetual cyclical project-based nature of the construction industry. Ultimately, it would allow companies a steady income stream that allowed them to plan for the future in a more structured manner.  Many of our better known and larger construction organisations moved towards this services model.

So why has it gone wrong;

1. The strategic thinking behind the move to a services approach was not thought through. It is difficult to stay part services, part construction, part manufacturing, etc. These companies needed to move to a services delivery entity.
2. Large parts of the sector did not fully understand long term risk. It is difficult to deal with risk on the execution of construction projects let alone looking at long term whole life risk.
3. Many of the failures were not necessarily down to the failure of the outsourced work but through the failure of construction projects that did not sit comfortably within a services company. The last three major company collapses had within them a series of weak loss-making projects which the parent companies could not cover.
4. The services sector is typically operated on a cost leadership perspective. Low tech, manual and low margins. The contracts would typically require operational improvement but not necessarily increases in cost recovery. In some areas of services, efficiency improvement is not possible through technology or mechanisation. Labour costs can only be driven to a specific point.
5. Services are low margin activity. Large turnover is needed to recover overheads. The nature of services/operational provision is not the same for different facilities or infrastructure support.
6. There was a lack of corporate governance and internal control in these organisations. Poor accounting practice and exposure to risky contracts were common.
7. The nature of service contracts and PFI were often ideologically driven. The first wave of the contracts seems to be structured to make privatisation and outsourcing succeed. However, as clients started to challenge the value for money proposition changes were made and the contracts became inherently risky.
8. The large clients started to drive down margins, resulting in lower profitability. This reduced cash-flow and overhead recovery.
9. Large construction companies do not have the maturity to be service operators.

While these may not be all the reasons, they do provide a view as to why we have problems. The holy grail has always been to smooth cash flow and have a controlled turnover. Unfortunately, many companies have not understood what they were getting into.

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