A cost of price

6 March 2013

The UK has been hit by a supply chain scandal in the past month that seems unrivalled in recent years. One of the most regulated industries has spectacularly failed. British and European consumers have been eating horsemeat disguised as beef. This scandal offers a warning on price driven markets. The introduction of horsemeat into beef products has affected the lowest price readymade meals. Opportunists in the supply chain delivered cheap ‘beef’ to undercut competition.

The recession is driving price competition in all markets and it is vital we are aware of the risks.

John Lynch, assistant director of engineering and architectural services with the department of general administration for the state of Washington warned in the early days of the recession of how the bidding process can change.

In a paper for the National Association of State Facilities Administrators and the Associated General Contractors of America Lynch explains that during a recession, the quantity of construction activity decreases, especially in the private sector, and the competition for the remaining work increases. Public works projects become sort after. "In past downturns," says Lynch, "owners learned that the hyper-competition for public projects has a number of negative consequences:

  • An increase in the likelihood that the low bidder has a bid price that is insufficient to complete the work. This could be due to an error in the takeoff, leaving something out by error, or intentionally under bidding to 'buy the job' with the hope of making up the difference in change orders
  • The subcontractor's bid to the general contractor may also be insufficient
  • Some of the contractors and subcontractors in this market are likely to be stressed and on the verge of bankruptcy

If a contractor defaults on a contract it will usually impact cost and schedule on the project. Lynch explains that, "for the subcontractor, taking work for under value may be a way of maintaining cash flow cow, but can lead to poor credit or possible bankruptcy. A subcontractor [going bust] is a serious problem for the project."

When projects are more scarce bidders that do not normal bid on the works might try their hand. This could well be true of the horsemeat scandal where some of the abattoirs being investigated were new to butchering horses and perhaps less familiar with the severity of the restrictions or more willing to take chances in a tough climate.

"As a public owner," says Lynch, "this presents several concerns. Do bidders understand the unique requirements in the project? Are bidders familiar with contract conditions? Are bidders prepared for the billing procedures and possible impacts to cash flow?"

Lynch warns against price driven contracts but the future of a project and getting the right price is inseparable. The focus is on understanding and trusting your supply chain and your contractors.

Those who have recently eaten a Findus 'beef' lasagna will appreciate what astronaut John Glenn meant when he said: "As I hurtled through space, one thought kept crossing my mind: every part of this capsule was supplied by the lowest bidder".