The construction business is risky. There aren’t many construction companies that have managed to survive for more than a few decades. As the typical construction company grows in size, with multiple offices and a larger team of support staff, they become particularly vulnerable to the business cycle when low margins become entrenched for an extended period of time. Smaller firms can quickly downsize as they adapt to the current business environment. Larger construction companies are trapped by their size, often drowning in their own overhead when profitable work dries up. With sizeable work in progress and a significant presence in the P3 space where sub-trades lack payment protection, a financial default by one of these major national construction firms would inflict significant pain on local contractors and government owners.
In the Canadian marketplace, use of the P3 model has grown substantially as large national firms have successfully convinced government bodies that they have developed a better mousetrap. Citing the superiority of the private sector in building, financing and operating large infrastructure projects, governments have increasingly adopted this procurement method.This approach allows projects to proceed without negatively impacting the public sector balance sheet. In simple terms, it’s a lease to own financing model. Proponents will often claim that P3s deliver projects on time and on budget. Unfortunately, data for overall project cost and financing is often murky or unavailable. What is certain is that political risk is effectively minimized for the current government. Bureaucrats also get to hand pick the project team and avoid undesirable proponents. A procurement approach that minimizes short term political risk and transfers financial risk to the future is hard to resist.
The free hand of capitalism does not exist in a vacuum. For the benefits of a free market to truly become effective, a politically defined set of rules must be promoted to guarantee open competition and success based on merit and innovation. The open tendering system for publicly funded projects using bonded contractors provides access to all qualified contractors, independently selected by the private sector. More importantly, sub-trades have payment protection through labour and material payment bonds. A properly designed procurement model automatically encourages innovation as the tenderer who figures out how to complete the project at the lowest cost is rewarded for his creativity. Under the P3 model, very few contractors have the balance sheet to finance and build a large project. This eliminates much of the competition, innovation and cost savings. A beauty contest between a small number of consortiums ensues. Any innovation is limited to what this group can bring to the table. Local knowledge or expertise is often missed entirely.
One of the primary benefits cited by P3 proponents is that it shifts risk to the private sector. Even though governments can secure financing at a much lower cost than the private sector, it is argued that through innovation and more efficient facility management, the private sector will find sufficient cost savings to make this procurement model the most efficient. This appears to be rooted in political bias rather than fact as there is little empirical data that supports savings in practice. Recently, the Auditor General of Ontario reported that Ontario could have saved up to eight billion on infrastructure cost if it built projects using more traditional procurement methods.
The elephant in the room is that many government analysts assume that these larger firms are too big to fail. Since we haven’t witnessed the financial collapse of a major construction company in quite some time, governments and their analysts have been lulled into a false sense of security. In the UK, large general contractors have recently found themselves in a financial squeeze as they find it increasingly difficult to find reasonable profit margins. Cost inflation for materials and labour on previously bid work combined with new prompt payment legislation is squeezing cash flow. Should a similar situation occur in the Canadian marketplace, perhaps triggered by the dramatic oil price fall in Alberta, the financial consequences to government and to local sub-trades, who usually do not have payment protection under the P3 model, could be significant.
The P3 procurement method can be suitable in rare circumstances for some specialized projects. Those of us who work intimately with the construction industry know that the P3 model is usually expensive, it minimizes competition and it can create unfair power imbalances within the construction team. Government decision makers often overestimate the financial strength and stability of the major proponents. The possibility of bankruptcy by a major national construction company is a potential risk that is frequently ignored. Since the P3 method usually fails to provide payment protection to sub-trades, and the existing work programs of these firms are significant, such a default could have widespread consequences for the Canadian Construction market.
Steve McConnell is client executive, vice president at CMW Insurance Services Ltd. He has extensive experience with construction bonding and insurance and is past chair of the Surety Association of BC.
