Client Briefing – Procurement and Key Supplier Risks
August 2020
With Covid19 pressures and an economic slowdown some firms will be again be bidding for cashflow at below cost. Although rationally this is medium term commercial suicide, it means that public bodies are potentially appointing suppliers who are financially weak and are at risk of becoming weaker (less solvent), and also increases the risk of corporate failure before the contract is completed.
Procurers in the public sector are caught between a rock and a hard place here because they would have to have a very good reason, especially with Covid19 budget constraints, to spend more public money than that suggested by the competitive process. That is the pressure to accept the lowest tender.
We have just completed a root cause analysis of a problematic contract, where the tender award to the lowest company resulted in:
late delivery;
adverse stakeholder reaction caused by beyond programme period with extended disruption to service users;
contractual claims; and
additional in house and external client-side costs to deal with the contract issues and poor performance.
The review concluded that “The successful Contractor's tender was too low in both an absolute sense, in that it was way below estimates, and a relative sense in that it was significantly lower than the next tender”
Factor to consider
Detailed below are some factors you may wish to consider before accepting the lowest tender:
The tender price on a construction or service project does not represent the final outturn price of the project;
If the low tender price, which does not cover a contractor’s costs, will normally lead to the contractor seeking other ways, such as claims and disputes, to recover additional costs;
A fixed price, lump sum contract can still be subject to risks and claims which can result in the price increasing;
The passing of risk to a contractor will attract a risk premium which may or may not represent good value for money;
Contracts which carry a high or higher risk exposure are not generally attractive to the market and can result in a lack of competition; and
The quality of the works provided, or services delivered, cannot be guaranteed if the monies reimbursed under the contract do not cover the costs of providing them.
The final point above particularly applies to service contracts. If the day rate or total costs looks and feels too low, it probable means the quality of service will not be what you as the client require.
Contractors with low tenders may be financially weak and seeking to generate cashflow through winning contracts, whilst their overall financial stability declines due to the unprofitability of the contracts they are delivering. Unless there is a clear strategic reason the contractor wants a contract, then clients need to ask:
Why is the contractor tendering so low?
Why is a contractor bidding below cost of delivery, when their driving purpose is to make a profit?
The most economically advantageous tender (MEAT) criterion enables the contracting authority to take account of criteria that reflect qualitative, technical and sustainable aspects of the tender submission as well as price when reaching an award decision.
Any criteria used must be linked to the subject-matter of the contract in question. The Regulations state that award criteria shall be considered to be linked to the subject matter of the contract where they relate to the works, supplies or services to be provided under that contract in any respect and at any stage of their life-cycle, including factors involved in:
the specific process of production, provision or trading of those works, supplies or services; or
a specific process for another stage of their lifecycle, even where those factors do not form part of their material substance.
The relative weighting of each criterion used to assess the tender submissions must be stated or, where this is not possible for objective reasons, they should be stated in descending order of importance.
The legislation lists the following criteria may be used, although others could be considered depending on the nature of the procurement:
quality
price or cost using a cost-effectiveness approach
technical merit
aesthetic and functional characteristics
accessibility
social characteristics
environmental characteristics
innovative characteristics
after-sales service and technical assistance
delivery conditions such as date, process and period.
Key risks
Key risks you may need to consider:
Are you appointing a financially weak/potentially insolvent supplier?
Are any of your current long term/key suppliers significantly financially weakened by Covid19?
Do you have a structured approach to monitor key supplier risks?
Do you have up to date contingency plans if a key supplier or partner should fail?
Do you know which key suppliers failing tomorrow would put vulnerable service users at risk immediately, in 24 hours, in 7 days?
Are you aware of your key supplier business continuity plan / IT disaster recovery plans?
How we can help
We can assist you and reduce risk through:
Supplier due diligence checks – this goes beyond credit checks and looks at the indebtedness of the supplier, cash generation history and uses key metrics to consider the financial risk of a supplier or a number of key suppliers.
Contractor Risk and Management Plan (CRAMP) – we have developed a set of templates to manage contractor risk and develop an associated management plan. These can be tailored to your needs and ensure all contract risk are identified and all contract information is held on one document. The documents would then be maintained by your contract managers and can be used of both revenue and capital contracts.
Review of your and delivery partners business continuity plans for key contracts, this will also seek to ensure co-delivery and partner arrangements have dovetailed continuity plans arrangements and recovery timescales.
Future risks
A significant number of your suppliers will have deferred their VAT payment due in respect of quarter 1 in 2020, an option to assist companies as part of the Covid19 business support measure annoyed by the Chancellor. This VAT will now be payable on 31st March 2021 and as such several insolvency commentators are forecasting a spike in corporate failures around this date.
Additionally, cashflow pressures will hit suppliers who furloughed staff as they return them to operational activities. As they want into lockdown, they received furlough funds and invoiced for work completed and in progress during March 2020. This boosted cash balances in the short term. As the furlough ends and staff return, businesses need to fund staffing costs before work is completed and invoiced. This could strain working cash balances and result in increased company insolvency cases.