Question

TORENTO CONSTRUCTION: ETHICAL CONTRACTING

On December 27, 2010, Cary Holmes, manager of the Supply Chain Management (SCM) group at Torento Construction Inc. (NCG), was in his office in Torento, Ontario, trying to organize the thoughts running through his head as a result of a recent bidding to save operating costs at NCG. There was no problem in terms of the final outcome; in fact, the bid was going to result in cost savings of 25 per cent, which was exactly what NCG’s founder and chief executive officer (CEO), Michael Wells, had asked for. The problem was that the cost savings represented only part of the story: He wondered whether the process to achieve the savings was unethical. As he gazed out of his office window, Holmes reflected on the series of events that had occurred over the previous few weeks.

INDUSTRY OVERVIEW

The construction industry’s main activities came from the construction of buildings, houses, and other engineering projects (e.g., utility systems and highways). The sector also involved the maintenance of infrastructure. Much of the work in the industry was done through contracts with the owners of construction projects, or through subcontracts with other smaller construction companies. In 2008, construction projects put in place within the Canada peaked at US$2.32 trillion.1The industry employed workers in a wide variety of positions, including labourers, carpenters, and electricians. During times of economic growth, both the private and the public (e.g., federal, state, and municipal government projects) portions of the construction industry flourished. The Global Financial Crisis and Industry Downturn Like many industries worldwide, the Canada construction industry experienced a drastic and unprecedented decline following the financial crisis and recession in the late 2000s. Economists agreed that the economic 1 All currency amounts are in US$ unless otherwise specified; FMI Corporation, CANADA Markets Construction Overview 2016, 2015, 2, accessed January 17, 2017, www.smacna.org/docs/default-source/business-management/fmi-s-2016-u-smarkets- construction-overview.pdf. downturn that began in 2008 was the most severe since the Great Depression of the 1930s, and the effects of the crisis were felt across the world.2 The financial crisis was triggered primarily by the subprime home mortgage industry, which saw high default rates due to misdirected regulation and aggressive lending practices; these events resulted in the near-collapse of many banks and other financial institutions, government bailouts across multiple industries, plummeting stock markets, unemployment, declines in consumer wealth, and the widespread collapse of businesses.3The construction industry was far from immune to the fallout of the crisis. In fact, in the Canada, construction was the industry that suffered the most during this period: the 568,000 job lossesin thissector comprised one-third of all Canada jobs lost in 2008. Before the crisis, Ontario province had been a hotbed of construction activity, powered by the constant building and maintenance of the hotels, casinos, and infrastructure of its largest city, Torento. With the economic downturn, Torento developersshifted their focusfrom the expansion of projectsto cost cutting. Jobs were shed, contracts delayed, and projects downsized. Keeping operations as lean as possible became the new priority for the few ongoing projects and operations in the surrounding desert.4 From October 2008 to October 2009, construction in Torento dropped 92 per cent, and the city saw its unemployment rate increase from 0.4 per cent to 8.0 per cent by November 2009.5With the sharp downturn of the construction industry, the rest of Torento’s economy sagged, sinking to levels last observed in the 1980s. Despite this dramatic decline, the more optimistic of the city’s builders and hoteliers pressed forward with their existing plans, with a renewed emphasis on efficiency and lean operations. In the new economic environment, cost cutting was the key to survival.

TORENTO CONSTRUCTION INC.

Founded in 2000 and headquartered in Torento, NCG was a medium-sized construction firm that employed approximately 1,000 people. The company focused primarily on construction work as main contractors for multiple projects on “the Torento Strip” (a central stretch of road known for its concentration of hotels and casinos) and surrounding areas. Only six years after it was founded, NCG went public and began trading on the Canada Stock Exchange. The firm showed strong growth after completing a number of acquisitions of smaller construction companies in Ontario, Qeubec, and British Colombia. In spite of the industry-level downturn, NCG actually found itself in better shape than many other Ontariobased construction firms. As of December 2009, due to its outstanding balance sheet and effective hedging strategy, NCG’s stock price dropped by only 11 per cent compared to the previous year, while comparable firms’ stocks had dropped over 45 per cent. With a number of long-term construction contracts on the horizon, NCG was in a good position to survive the economic downturn. Accordingly, although business was not exactly thriving at NCG, there were some reasons to be optimistic. As a lean, dynamic company that had focused on technological advancements, acquisitions ofsmaller firms, and an aggressive approach to acquiring new clients, NCG looked as though it might even be able to profit from the losses of rival companies who found themselves in worse situations. Rumours began to surface about NCG making another acquisition. However, this mood of optimism did not last. By December 2009, the few multibillion-dollar projects that had promised to provide employment for the construction firms in Torento had either been cancelled, put on hold, or scaled down. The financial crisis showed no signs of being relieved in the Canada, and the outlook for the survival of Ontario’s construction firms was grim. It was at this point that Wells (NCG’s CEO) called an emergency meeting with NCG’s SCM group.

THE MEETING

Although he was not quick to anger, Wells was angry now. Sitting at the head of a long, wooden conference room table, he clenched his fists and pounded the table, emphasizing the gravity of the situation that his company was facing. Sitting around the table and witnessing this display of anger were the five members of NCG’s small SCM team; most of them were both young and relatively inexperienced. The team included the SCM manager, Holmes; two specialists, Matt Daniels and Tory Falk; and two analysts, Michelle Grover and Sean Nichols. Holmes had been with NCG for four years. He was chosen to lead the SCM group when it was created because of his 15 years of experience in managing supply chains and logistics—including managing the contracts and relationships with subcontractors—at various other construction firms in Torento. In contrast, the other team members had considerably less experience. The two specialists, Daniels and Falk, had only recently graduated from business programs at prestigious universities in the Canada, and the analysts, Grover and Nichols, had had little experience in supply chain management before being transferred to the SCM group from other business units within NCG. Nevertheless, although their tenures with NCG had been relatively brief, the members of the SCM team had made small but consistent progress throughout the economic downturn in lowering costs among the company’s various internal business groups. Unfortunately, this progress did not meet Wells’ expectations. “It’s not good enough!” the CEO exclaimed. “We’re looking at a large-scale economic downturn here! The current market is not sustainable for us. If we are to meet our targets with the current budget, we need to see at least 25 per cent reductionsin our capital and operating costs. Basically, we need to be in survival mode!” Holmes, who was never one to shy away from a challenge, understood his boss’s request completely. He looked around the table at the different members of his team. His gaze was met with looks of shock and awe. He then turned to lock eyes with the CEO, stating, “You can count on us, Wells. We will find a way and you will get the result. I know it will not be easy, but we will try our best. Please, give us some time.”

THE BIDDING

Since the meeting with Wells, Holmes and his team had been working as hard as they could, and they were producing very impressive results for NCG. They were seeing compliance with a mass letter that they had sent out asking for cost concessions from their vendors. In addition, the team members were executing bids and requests for proposals that resulted in reduced rates, increased discounts, and greater efficiencies. The young team was operating at a level that Holmes had not thought possible given the limited number of employees he had at his disposal. Yet the daunting target that the team members had to meet always seemed to overshadow the progress they made. A 25 per cent reduction in all costs contributing to capital and operating expenditures was almost unheard of; they still needed to cut more. Holmes thought that there was one particular expense category that had been left untouched by the SCM group: costs of subcontracting. The construction industry relied heavily on subcontractors, especially when the project required additional labour that exceeded a company’s capacity. Project companies like NCG acted as the main contractor, and these firms then subcontracted plumbers, carpenters, electricians, landscapers, drywallers, painters, roofers, and flooring specialists. Holmes had long been looking for an opportunity to scrutinize this category, because he felt that NCG was not fully attentive to the potential cost savings of re-evaluating its subcontractors. A single manager who coordinated with three of the company’s subcontractors was in charge of organizing the acquisition of outside labour that NCG used for its large projects. This manager, Bernie Miror, was essentially responsible for sourcing the subcontracting servicesthat NCG used. Miror had been with NCG for seven years and was a fast riser within the company ranks. He felt that his management was contributing to the company’s overall efficiencies and success on the projects it had completed in Torento. Miror knew the CEOs of the three subcontracting companies that NCG used on a first-name basis. He played golf with them in a company tournament every year, and received bottles of wine from them as Christmas gifts. Therefore, when Holmes called him about helping with cost reductions for his department, Miror politely reassured him by saying, “No, I can handle it. Just give me some time.” Miror hung up the phone, and subsequently called his friend, who happened to be the head of the largest labour service company in Ontario. The conversation initially consisted of a few friendly jokes and updates about each other’sfamilies. Finally, Miror brought up the topic of cost reductions. The call concluded with Miror's counterpart throwing out a number: “I understand your concerns . . . . How does 10 per cent off the all-inclusive rate sound to you?” Miror felt that the discount was more than sufficient, and agreed immediately. He then more or less repeated the same phone call with his friends at the two other labour service companies. When Holmes received an email from Miror reporting the 10 per cent reduction in subcontracting costs, he was perplexed and annoyed. He had been asked by his CEO for a 25 per cent reduction; 10 per cent just would not suffice. It had become obvious that Miror was not using proper techniques in negotiating with vendors, and this was negatively affecting Holmes’ cost-reduction initiative. Holmes had been preparing a bid document for the subcontracting expense category, and he had planned to send it to Wells and the other executives with Miror's help. Holmes refused to appear ineffective, so despite Miror's actions, he sent the bid document to a pre-screened group of labour service companies. All the companies included in the bid had the capability to meet NCG’s external labour demands when the company needed them. The deciding factor would be how much each company would be willing to lower the price they charged, which was critical in reducing operating costs. The bid included the three companies Miror currently used, as well as six other companies that operated in Torento and the surrounding areas. It seemed that these six other companies were excited about this new business opportunity. As the deadline for bidding approached, Holmes received nine proposals for the labour subcontracting position, six of which were not only better prepared and more thorough than the three companies NCG already worked with, but also included rates in line with Wells’ request for a 25 per cent cost reduction. Holmes was ecstatic with the results of his bid; not only was he able to finally bring about change in the subcontracting category, but he would also be able to fulfill his promises to NCG’s CEO. He felt this was a huge win for his team, and one that would eventually improve the company’s financial performance during an economic downturn. Holmes painstakingly compiled the data he had received, analyzed it, and formulated it into a recommendation. It turned out that the three companies that Miror insisted on using were asking the highest rates, at only a 10 per cent discount. In his analysis, Holmes stressed the confidential manner in which the data must be treated; the proper legal and ethical procedure was not to disclose any information about the other participants’ submissions. Once he was satisfied with the document, Holmes sent Miror the final copy, along with a request to meet to discuss plans to switch from using the three current labour providers to any of the other six firms that had submitted better bids. New Proposals The following day, Holmes received an email from Miror. The email contained new proposals from the three companies that had submitted bids with the highest costs. In the three new proposals, the rates had been drastically reduced to match the lower rates—surprisingly, to the exact dollar amounts—proposed by the other respondents. Yet other than the reduction in rates, the proposals had not changed much. Holmes was furious. He thought that Miror had simply looked at the document Holmes had sent him, and upon discovering that his “buddies” would be losing NCG’s business, had contacted the three executives and warned them to lower their bids. In fact, Holmessuspected that Miror had probably told them exactly how much they would need to take off the price in order to continue providing theirservicesto NCG.

Assignment Questions: 1. What facts should be considered in evaluating Miror's actions? (address at least three facts and using the case content, explain why these facts should be considered)

2. Who would be the primary and secondary stakeholders with respect to Miror's decision? ( address at least three primary and three secondary stakeholders)

3. What are the possible consequences of Miror's actions? When estimating consequences, consider the magnitude and probability of the consequences based on both short-term and long-term perspectives (see Exhibit TN-1). (list at least three consequences and explain about them as the question asks you ).

4. Are there any relevant ethical principles (other than consequentialist principles) or violations of human rights or justice involved in this decision? (at least 2 approaches)

5. In light of all of the above considerations, what do you think Holmes should do? How can NCG prevent unethical decisions in the future? (at least 4 recomandation for each one)

Answer 1

1: The facts that should be considered in evaluating Mirror's actions are:

* Mirror was friends with current subcontractors of NCG, and he was choosing the personal relations over company benefit in the need of the hour. Which showcases an unethical approach.

* The three subcontractors resubmitted their bid after initial submission, and the new bids were exactly in range of bids submitted by others, which means they had a hint on bidding from Mirror. This rigs the whole bidding process and is completely unethical.

* Even when the company was trying to reduce the operations capital by 25%, Mirror had agreed with the subcontractors for 10 % reduction on labour which was not as per planning by Holmes, which could have been more effective. Miller was avoiding discussion with Holmes and rather taking insights and delivering them to the subcontractors who were his friends, which was completely unethical.

2. The primary and secondary stakeholders with respect to Mirror's decisions are:

@ Wells, Holmes and the three subcontractors are primary stakeholders, who have a direct impact of Mirror's decision. Wells could lose the position of CEO if he could not manage the capital, same goes for Holmes, and sub contractors could lose their contract with NCG if Mirror did not support them.

@ The New Bidders who could potentially get work from NCG, the Competitors of NCG who could suffer an advantage or disadvantage because of MIrror's decision and the Business Partners of NCG were Secondary stakeholders in this situation.

3: The three consequences that could result due to Mirror's actions are:

a.) The negative public image and media image could take place for NCG, if word gets out that the bidding process was rigged and someone from inside helped the three original sub contractors with information on Bids by other competitors.

b.) The three sub contractors could have continued their contracts by reducing bids with the help from Mirror, however the competitors in the Bidding process could have worked more efficiently for NCG as compared to the original sub contractors. THis could be a long term loss for NCG.

c.) Thirdly, if the other sub contractors get to know about the false bidding, then in future NCG could suffer from no other option being available to give contract to apart from these 3 original subcontractors. They could lose support from the market because of being biased.

4, 5.) The relevant ethical principle and practice that Holmes should follow in this situation is to let the management or Michael Wells know about the whole thing in detail along with facts and numbers, and suggest the management to conduct a new bidding process excluding the original 3 sub contractors, or taking new bids from them also, so that there is no biased process being followed.