“… PPP is one of those financial inventions that was sold as being a win-win for both sides: the companies could be awarded lots of lucrative contracts to build stuff for the state; the government would get new infrastructure more quickly and without the financial risk, as private companies would bid for the work and the market would ensure taxpayer value.
At least, that was the theory. What actually happened was that companies kept bidding for projects, but tough competition meant the contracts came with skinnier and skinnier margins. So, if problems occurred, a contractor’s 2% profit would not just be wiped out – huge losses could be incurred too.
Sam Cullen, an analyst at investment bank Jefferies, said: “That is why construction can be such a fundamentally horrendous business. Under pressure to grow the top line and operating on wafer-thin margins, everyone bids each other to death. It’s a situation not helped when your largest customer, the government, is under huge pressure to get value for money and is more susceptible to accept the lowest bidder.”
The big question is: why do companies keep bidding, if the contracts can cause so much pain?
The answer probably lies in the structure of major PPP construction deals, because they hand the contract winner a large chunk of cash upfront.
Work on construction can then begin, while contractors like Carillion may not need to start paying sub-contractors for another 120 days.
During those four months, much of the upfront payment might be used to pay other debts within the business, meaning these deals can create situations where firms have to keep winning new contracts just to keep going.
Or, as it turns out, not keep going.”