Although it isn’t a household name here in the US, the recent Carillion bankruptcy in the UK serves as a warning to us all. A reminder that there’s no such thing as “too big to fail”.
It’s also a case study in normalcy bias, “a belief people hold when facing a disaster. It causes people to underestimate both the likelihood of a disaster and its possible effects, because people believe that things will always function the way things normally have functioned.”
Who is Carillion?
Carillion was one of the UK’s biggest government contractors. I won’t repeat all their statistics here but they had their hand in most major construction projects, facility management and infrastructure operations for the British government. They employed over 43,000 and their collapse “threatens the solvency of hundreds of subcontractors and smaller businesses.” according to the New York Times.
What happened to them?
After several profit warnings and a collapse in share price, Carillion declared itself to be insolvent last month, with $1.35 billion in debt. Contributing factors were:
- Large contracts that were underbid and had little-to-no profit margin
- A growing employee pension deficit
- Little collateral for additional borrowing
- Overly rapid expansion (which drains cash and requires capital)
In the end, they simply had too much debt and ran out of cash to operate after a last-minute appeal to the British government for a bail-out was denied. The company will be liquidated.
The ripple effect in bad debt, loan defaults and job losses will sweep through the economy.
The reality is that for the British government, Carillion’s suppliers and the public in general, there was a concern about the financial strength of the company. The concern seems to have been suppressed by a sense of complacency and the belief that nothing bad could happen. After all, this huge company would never be allowed to fail, right?
Does this remind you of another place and time? (Hint… the US in about 2008, right before Wall Street collapsed and the financial crisis hit).
It’s called “normalcy bias” and we’re facing it again today.
Credit insurance & Carillion
Credit insurance is very widely used in the UK. Suppliers routinely ship to customers only if credit insurance protection is in place. In the 2008-2009 financial crisis, the British government considered subsidies for credit insurance companies to incentivize them to continue coverage on risky accounts because of the stimulus it provided in the economy.
Credit insurers will pay out an estimated $42 million in losses on Carillion. For those who had coverage, it could be a lifesaver. This is a small fraction of the losses caused however as Carillion had over $750 million in accounts payable. Those who had insurance increased their chances of survival but for the many who chose not to protect themselves, the losses could be severe.
What’s the lesson for us?
The first lesson is to acknowledge that there is risk in selling to each and every customer. Don’t fall into the trap of thinking anyone is immune to financial difficulty, using legal loopholes or simply deciding not to pay out of spite.
Secondly, the risk is often indirect. In Carillion’s case, suppliers further down the chain will likely face loss because their customer sold to Carillion OR because their supplier’s bank suffered large loan losses and reduced exposure to the supplier’s customer.
Finally, no company is too big to fail. In the Carillion example, suppliers and employees knew the company’s finances were an issue but they wouldn’t accept that the banks or government would not rescue the company.
Conclusion
Don’t let normalcy bias put your business at risk. Don’t assume that something can’t happen only because it hasn’t happened to you. Take a look at your own situation and objectively measure the potential for loss. To have a conversation about strategies to protect your business, email me at tate_parker@coface-usa.com.
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