As infrastructure programmes increase in scale and complexity, managing supply chain risk has become a priority concern for contractors and project managers alike. But what can and should they be doing to address this issue?
Over a year since the collapse of UK outsourcing giant Carillion, the construction industry is still learning lessons from what happened. News of financial difficulties at Interserve, which broke at the end of last year, sent further shockwaves through the industry. Coming so soon after the demise of Carillion, this close call for Interserve has heightened concerns within the industry and further highlighted the need to improve the management of supply chain risk.
One of the main problems is that, historically, tier one contractors have been forced to accept onerous agreements, apportioning too much liability to them. Further down the supply chain, risks and responsibilities have become diluted until there is little, or no, accountability for subcontractors and suppliers. This is exposing one part of the supply chain to an exceptionally high level of risk.
At the same time, pressures on operating margins and cash flow have become more acute for many contractors and a growing number are now pushing back on contractual terms to limit their liability and risk exposure. They know that pushing back in this way could leave them out of work, but they also know that taking on too much risk could leave them out of business. Simply pushing risk up or down the chain is not a sustainable solution however and a "whole supply chain" approach is needed.
The key to managing supply chain risk is to provide a strategy that works for all project partners, ensuring they are able to profit from their involvement. This may involve the use of quantitative risk assessment at an earlier stage in the process, so contractors understand the full extent of their liabilities, and price their activities accordingly. This is particularly necessary on specialist or highly-complex projects, since a project manager’s lack of experience could have dramatic time and cost implications.
The next step is ensuring that risk terms are incorporated in the contract from the outset and attributed to the correct stakeholder. Although risk may often sit with the main contractor, a clear differentiation should be made between the party carrying the liability and that responsible for managing the risk. For example, tier one contractors may be largely responsible for managing risks, but their customers need to accept financial ownership of them.
Having identified where liabilities best sit within the supply chain, contractors must be clear about what they expect from those lower down the chain. They should also be more confident in confronting customers in situations where the risk versus reward ratio may need to be rebalanced. Of course, contractors may need to keep their expectations in check – businesses that don’t have the financial means will be averse to absorbing any additional risk since they don’t have the funds to act as a buffer if something goes wrong.
In order to achieve a shift in responsibility and a fairer distribution of risk and reward, greater collaboration across the supply chain is needed. Taking time to fully understand the risks and consequences during the tender and procurement process will encourage suppliers at all levels to accept some degree of liability.
The collapse of Carillion has raised important issues within the construction industry, particularly regarding the supply chain’s top-down approach to risk management. Squeezing contractor margins to the bone is not sustainable and a fairer, and more commonsense approach to risk management involving all project or programme partners is now a must.
☛ Bill Zuurbier is director at risk management consultancy Equib.