No-one likes a cheapskate

It was obvious even to the most casual of observers that Carillion was struggling over the past six months. Cost overruns on projects had sapped cash flow, leading to ballooning debt and worrisome delays in paying subcontractors.

And yet, the UK Government kept awarding hundred-million-pound contracts to the facilities management and construction giant right up till it called in the liquidators. Why is anyone surprised? Governments, business and even we consumers are incentivised to push our suppliers of goods and services as low as possible to secure a better deal. Businesses are thinking of their profit margins, while we tend to care about having more money to spend elsewhere. As for government departments, their budgets have been squeezed more than most, pushing them to put their trust in a builder that’s too cheap to be true.

Carillion’s collapse is a timely reminder that squeezing your suppliers like an icy-veined python doesn’t always end well. Pushing part of your supply chain to the point where they are desperate just to maintain market share or cover costs is a short-term strategy with large risks. Better profits today is likely to be followed by the end of your supply at best, or at worst significant disruption to your activities and possibly future losses.

Yes, Carillion’s managers have a lot to answer for and their reputations lie in ruins. I will leave others to commentate on what other penalties they should face. I want to focus on the wider issue.

If we believe in capitalism, then we must understand that for it to function everyone needs to benefit – not only the most powerful. Everyone needs to be allowed to make a profit. If not, the market shrinks and with it choice. And a lack of choice ultimately leads to higher prices and lower quality due to a lack of competition.

When I was a fund-of-funds manager analysing boutique asset managers I never focused purely on getting the best or lowest price. It was really important that they were commercially viable. If not, they would be likely to shut down, incurring liquidation costs and a forced sale of assets. Not good.  In addition, if their margins deteriorated they might be forced to accept more inflows then they felt comfortable with. This boosts their revenue, but often leads to worsening performance and mediocrity.

In the pensions world, the Government has been vocal in encouraging ever lower costs. There’s no doubt that the industry had many products and structures with opaque (high) charges and mediocre performance. But the answer is transparency, education and a focus on results, not lazily directing the consumer to the lowest-price offer.

We will end up with only the big players and “me too” mediocrity. But it will be a bargain, won’t it?