Governments markets are made up of the spending of National and Local governments. Each year the government spends billions of pounds on a range of services both to support its internal operations and to provide the public with services such as defence, education, road systems, public order and safety, housing, recreation and health care.
Many government contracts are very large and can involve millions of pounds of public money. Because the government and its agencies spend funds to buy the products they need to provide services, they are accountable to the public and, as the public’s needs and priorities for services change, so does the demand for products within government markets. The buying process is also influenced by the ‘political atmosphere’ of each government and, over recent years, in response to the need for greater accountability, there has been increasing emphasis upon ‘value for money’.
For certain companies and in certain industries, the government, through its departments, is the largest single client. This is the case in the construction industry where, despite the privatisations of the 1980s, the government still spends significant sums upon vital pieces of the nation’s infrastructure such as schools, hospitals, roads and public building projects.
The established practice has been for the government department (or Local Authority) to employ an engineer or architect to design a project and ask for tenders from construction companies to build the project. Under this system, the government department selects only a few firms, negotiates specifications and terms and eventually awards the contract to one of the negotiating firms. The successful contractor is then paid stage payments throughout the work for the construction undertaken.
In 1992, the then Chancellor of the Exchequer, Norman Lamont, launched the Private Finance Initiative (PFI), whereby companies wishing to obtain work on certain government infrastructure projects would have to fund the projects and retain a responsibility for their upkeep until the government repaid the finance. The aims of PFI were essentially threefold:
- to turn the government from a provider of services to the public into a purchaser of services for the public
- to reduce the amount of capital expenditure the government needs to borrow in an attempt to control the Public Sector Borrowing Requirement (PSBR)
- to inject private sector management and skills into projects which have traditionally been the domain of the public sector.
This case study focuses upon how UK-based Tarmac, a key name in the international construction industry, has taken advantage of the opportunities created through the government’s Private Finance Initiative.
Britain’s earliest roads were built by the Romans as they spread their influence. But, for many centuries after the Roman occupation, there were no real roads. The first serious attempt to modernise the engineering and administration of the country’s roads was made in the early 19th century by John Loudon McAdam. His achievement was to create a proper professional status for road engineers and administrative arrangements for the Turnpike Trusts - the PRIVATELY FINANCED toll roads of the early 19th century.
The Tarmac story itself began in 1901 at the dawn of the motoring age. A barrel of tar spilled from a horse-drawn cart at Denby in Derbyshire. Shortly afterwards Mr E Purnell Hooley, the county surveyor of Nottingham, noticed that after the barrel fell, the resultant mixture of tar and fine blast furnace slag debris from the local ironworks was hard, strong and dust free! It is difficult to believe that this solution to the problem of dusty roads, about which all travellers complained - particularly the huge number of cyclists - could be so simple. But it was and it turned out to be more durable once Purnell Hooley had found out how to mix the slag with tar before it was laid. He called the product ‘Tarmac’, recognising McAdam’s contribution to roads development and set up a company in Nottingham in 1903 - the ‘Tar Macadam’ (Purnell)
Like many new inventions though, the inventor is not necessarily the best person to develop the product commercially and the early financial direction of the venture was erratic. The story may have ended then but for the intervention of Sir Alfred Hickman, MP for Wolverhampton, who owned a thriving ironworks on the edge of the town. In 1905, he became chairman of the venture and changed the name of the company to Tarmac Limited. Tarmac the material and Tarmac the company had arrived.
From its beginnings as a ‘one product’ company, the Tarmac Group has grown to become a world-class provider of high quality products and services which now cover every aspect of the construction industry. The Group has two principal activities - Heavy Building Materials, embracing aggregates and the manufacture of building materials and Construction Services, covering construction projects and professional services.
Heavy Building Materials Tarmac is the largest supplier of crushed rock, asphalt, sand and gravel to the UK construction industry. Tarmac owns substantial aggregates, ready-mix concrete, cement and lime businesses in mainland Europe and North America and has around three billion tonnes of mineral reserves worldwide. Tarmac is also a leading manufacturer of heavy pre-cast concrete products, including bridge beams, culverts, safety barriers and railway sleepers. It is a market leader in pre-cast concrete flooring and a leading supplier of concrete building blocks in the UK, - and also has significant concrete products businesses in northern France, Belgium and the USA.
Construction Services Tarmac’s Construction Services includes the largest civil engineering and building contractor in the UK, with interests in mainland Europe, South East Asia, the Middle East, Canada and the Caribbean. All aspects of the construction industry are covered, with particular expertise in civil and power engineering, industrial and commercial building, tunnelling, mechanical and electrical services, social housing and plant hire.
Within Construction Services, Tarmac’s professional services activities represent the UK’s largest multi-disciplinary consultancy, offering services ranging from feasibility studies and design, through to management of a complete project or facility, together with scientific consultancy, information technology, materials testing and facilities management. Shaping the business around Heavy Building Materials and Construction Services has enabled Tarmac to take advantage of the opportunities derived through the Private Finance Initiative and to reach its corporate aim ‘to be an innovative, world class provider of high quality products and services which add value to our customers in the built environment’.
The required skills for any construction project include proven ability to design, construct and commission the work. The ability to co-ordinate and manage the design and construction works is vital to PFI projects where late completion will cause revenues to be delayed.
An important part of the PFI process is ‘bid management’. The bidding process for PFI projects is notoriously expensive and can consume a considerable amount of time and money. Therefore, the resources expended in the bid process need to be closely budgeted and controlled. The majority of bid costs are incurred in structuring the finance package and negotiating the legal agreements. Though in-house legal and financial staff are supplemented by the use of external consultants and advisors, it is very necessary to have some of these diverse skills in-house. These projects represent significant investments for Tarmac and some of the processes are not dissimilar to those undertaken by the Group when investing, for example, in new quarrying facilities.
Tarmac’s Private Finance Unit co-ordinates the input from its different businesses when putting together a PFI project. Designers and operations staff work closely together to optimise the ‘whole life costs’ of each project. For example, when building a new road it may be more efficient and cheaper in the long-run to install expensive surfacing which has a long life, as opposed to a cheaper product which would require frequent replacement. In addition to finance borrowed from banks, Tarmac invests its own funds into PFI projects through its own financial specialists.
Changes in the external environment
Many of the core skills required by a company pursuing PFI projects already existed within the Tarmac Group. For example, Tarmac regularly invests funds in operations and new facilities at its quarries. The relevant ability to deal with project finance was already available in-house and this was enlarged to reflect a new workload. Tarmac’s work in construction also involves negotiating contracts of varying complexities. The ability to do this within the company, particularly when coupled with the skills of external advisors, has proved to be a key resource for use in PFI work.
The diverse objectives and different types of work associated with putting these projects together and in financing them, has led to the employment of specialist staff. Tarmac’s Private Finance Unit brings together people of different backgrounds such as lawyers, accountants, builders, engineers and bankers who, collectively, have the relevant experience and expertise to win and manage PFI projects profitably.
The main implications of the changes for Tarmac
It is not just the skills and resources that make PFI projects different from traditional construction work. The role of the contractor is also fundamentally different. Tarmac now has to approach projects, with a longer horizon – typically 25 to 30 years, instead of the traditional involvement over 3-4 years. On PFI projects Tarmac essentially provides a service rather than a tangible and traditional product. Working as a service provider requires a slightly different focus and Tarmac has expanded its initial skills base to accommodate the new resources needed to take on PFI work. Tarmac has also had to manage the design process in a manner which minimises the whole life costs – not just the initial expenditure. Tarmac’s extensive experience of design and construction management has allowed it to fulfil this role efficiently.
Tarmac has a long history of managing the quality of all of its operations to the highest standards and was one of the first construction companies to attain quality assurance registration. This ability to maintain rigorous quality standards on construction projects provides Tarmac with great confidence that maintenance costs will be minimised as a result. This is just one example of how existing skills within the Group have been utilised to good effect on PFI projects. Finally PFI work also meant the need to work with partners. Tarmac has had to select partners carefully in order to help it adapt to changes in markets. Tarmac’s success in obtaining PFI contracts can be attributed to careful strategic development which has responded to the changes since the launch of PFI.
Forging relationships with other companies
The range of projects awarded by the government has been diverse. This has involved projects which successful contractors are required to manage for a long period of time and some require skills in areas where Tarmac has had limited or no previous experience, such as prison management and healthcare.
Healthcare projects such as new hospitals usually include the requirement for the private sector company to manage all non-clinical services in the new facility. There are also requirements for the new facility to be equipped with the necessary medical equipment. Tarmac acquires the necessary skills by partnering with a medical operations company, United Medical Enterprises, on its hospital projects.
Major motorway construction projects require the contractor to maintain the road for a period after construction, typically 25 to 30 years. This type of work, until recently, was undertaken by National and Local Government. In mainland Europe, however, private sector companies have managed motorways for some years. With this in mind, the French road operator, Transroute is one partner (together with Hyder Investment and John Laing) with whom Tarmac is working on motorway projects in this country. The four companies have formed a joint venture company, UK Highways and in October 1996 the consortium was awarded the largest PFI road contract let to that date – to improve, operate and maintain 122 kilometres of the M40 between London and Warwick.
All of the companies mentioned have brought complementary skills to the projects on which Tarmac works. The combined skills of the participants in any project create a synergy that allows the group members to participate in work where an otherwise lack of ability in one specific area of the project would normally prohibit involvement.
As the length of most of the projects under the PFI initiative is 25 years it is not easy to identify the true value of each project in which Tarmac engages. However, all of these contracts have provided Tarmac with the opportunity to use and develop a wide range of skills and resources. Tarmac’s expertise within the construction industry includes the supply of aggregates and concrete, design, construction and facilities management. Many of the PFI projects have provided Tarmac with the opportunity to use its broad range of skills. This means that not only is each project providing investment opportunities for Tarmac, but is also providing work for its wide range of businesses.
The response of Tarmac to the challenge laid down by PFI has meant that instead of relying solely upon highly competitive construction contracts, the Group has the opportunity to use its different businesses and skills to take on major Government contracts. The profitability of Tarmac’s construction operations is enhanced by winning new contracts which make profit streams more predictable. Successful PFI contracts provide a longer term revenue stream which therefore helps to strengthen the business.
Case Study - Fazakerley Prison
A privately financed prison is rapidly taking shape on Merseyside at Fazakerley - the first under the PFI. Building work is now well advanced on the prison which is due to start receiving prisoners in mid 1998. Her Majesty’s Prison Service (HMPS) chose Fazakerley Prison Services (FPS) - owned equally by Tarmac and Group 4 - to design, construct, manage and finance the prison for a concession period of 25 years. The construction of the 600 place prison will cost £70 million and it will cost around £15 million a year to run - with Tarmac maintaining the building and facilities, like catering and cleaning and Group 4 providing security services, welfare and training.
The project is a partnership between HMPS, FPS, Tarmac and Group 4 - ensuring complete agreement as to the facilities and services to be provided. Tarmac commenced the detailed planning application and set in motion the manufacture of the precast concrete cell units immediately on becoming the preferred contractor in mid-1995. Group 4 was closely involved in the design and other stages to ensure that all its operational requirements were taken into account prior to construction.
Six house blocks, each designed to accommodate 100 prisoners, are being constructed at Fazakerley. The individual cell units are transported to site as required from a Tarmac Precast Concrete factory in Somerset to achieve fast-track assembly of the house blocks. The construction also includes the erection of perimeter walls, entry and visitors’ areas, medical, catering, physical training, education, administration, laundry and other ancillary services. The complex will have a high-tech alarm system and the surrounding area will be fully landscaped.
The project is an example of how resources from around the Tarmac Group have been drawn together to obtain a PFI project. While Group 4 provides the necessary prison management resources, Tarmac injects its skills into the project through several key subsidiaries to design and build it - and provide an ‘after care’ service to maintain it. The finance was arranged by ABN AMRO Bank NV (Netherlands) and Bank of America. Once complete HMPS will pay a set fee for each available inmate space.
Tarmac is involved in the first PFI project in the education sector at the University of Greenwich. The construction of 664 bed spaces and catering areas at the Avery Hill student village cost £12 million and was opened in time for the 1996/7 academic year.
A single agreement was entered into between the University and Tarmac which involved the funding, design, construction, facilities management, catering and even summer letting of the accommodation. The university benefits from fixed costs over a 30 year period because the provision of the student accommodation and the costs are budgeted to be met by student rents. This results in a project which is designed to be self-financing. Ownership of the property will remain with the university without further payment at the end of the agreed term.
The finance was provided by Varsity Funding, a company established by Bankers Trust Company, Redheugh and PRICOA Property Investment Management (PPIM), a subsidiary of The Prudential Insurance Company of America.