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REPORT OF THE ESTABLISHMENT UNIT
1. ROADING LATE
INTRODUCTION
The purpose of this report is to advise the Council of the conclusions reached by the Establishment Unit and to make a number of recommendations. The Establishment Unit was set up by the December 1995 meeting of the Council "to consider the options with regard to transferring an undertaking to a LATE (Local Authority Trading Enterprise) and make recommendations to the Council on the option to be chosen" in response to implications arising from recent changes to the law in regard to land transport matters. The following extracts from the report to the Council in December are helpful by way of background to this report: 2.5 Competitive Pricing Procedures
The new provisions of the act say that no payment from the (District Council) Land Transport Disbursement Account is permissible unless the price is determined by a competitive pricing procedure and no payments are permitted to a Local Authority or to a LATE:
(a) Unless the Board is satisfied that the LATE was established and an undertaking has been transferred to it, and it is operating in accordance with the Local Government Act and also with any ministerial determinations.
(b) Excepting for minor and ancillary works done by Local Authority business units formed and operated in accordance with any ministerial determinations. This latter requirement has transitional provisions of at least a third of the minor and ancillary work subject to competitive pricing procedures in the 1997 financial year (July 1996-June 1997) and at least two thirds in the 1998 financial year (July 1997-June 1998).
The new requirement to transfer an undertaking to a LATE before it becomes eligible for funding from the Land Transport Disbursement Account means that our LATE, Christchurch Streetworks Limited, will not qualify unless we spend the time between now and when this provision comes in to force, modifying our LATE so that it does comply by transferring some kind of roading undertaking to it. This is discussed in further detail later.
Desired outcomes in this area include a continuation of competitive tenders for roading works and avoidance of significant organisation disruption and so costs incurred. It is considered that we must stay in the market to achieve both these outcomes.
2.7 Determinations by the Minister
The new Act provides for the Minister from time to time to set operating and reporting requirements for LATEs and business units (doing minor and ancillary and professional services).
1 Cont'd The ministerial determination under this Act will take the effect of a Government regulation. The determinations will set the operating and reporting requirements for LATEs and business units. No draft determination exists for LATEs and current indications are that providing officials in Wellington are satisfied with the composition of any LATEs arising that no such determinations will be forthcoming.
3. TRANSFER OF AN UNDERTAKING TO A LATE
Our existing LATE, Streetworks Management Limited, is a management LATE, that is, it exists solely to tender for Transit New Zealand subsidised roading works publicly tendered in the current area of major works. Its current structure sees it hiring management and administrative services from the City Council and sub contracting all work back to the City Council's Works Operations business unit following the successful winning of a tender. For it to comply after 1 July 1996 an undertaking must have been transferred from this Local Authority to a LATE.
There are strict procedures to be followed in the transfer of an undertaking to a LATE. In essence, an Establishment Unit must be formed:
(a) To identify with reasonable precision the undertaking that is to be transferred to the LATE.
(b) To value any such undertaking or determine a method for its valuation.
(c) To determine the price that should be paid or the method for determining the price that should be paid by the LATE for any such undertaking and the extent to which the price should be met by the issue of equity securities and debt securities to the local authority from which the undertaking is to be transferred.
(d) To specify the debt securities required to be issued pursuant to Section 594zi of the Local Government Act.
(e) To prepare in draft form a Memorandum of Association, Articles of Association, and Statement of Corporate Intent for each LATE.
(f) To determine the best manner in which, and time within which, any undertaking of the local authority should be transferred to any LATE.
(g) To determine a fair and equitable system for the transfer of appropriate employees from the local authority to the LATE (but without making determinations in respect of individual employees).
The establishment plan, including any divestment plans, must be made public.
The Establishment Unit does not have the power to form LATEs and make investment/divestment decisions. Rather, it makes plans and recommendations to the Council. Membership of the Establishment Unit is not prescribed either in number or in composition. In this case it would seem wise to draw on those with experience as directors of Streetworks Management Limited together with one or two senior management staff to provide input from an organisational perspective.
1 Cont'd In our case, the following options exist to transfer an undertaking, ranging from the least to the most:
(a) The transfer of our Bitumen Products Plant with sufficient management and support for it to tender for Transfund works although it may still source some of its inputs by way of sub contracted services.
(b) The transfer of the Bitumen Products Plant plus some of the heavy roading machinery.
(c) The transfer of the Bitumen Products Plant plus the heavy roading plant, plus some of the roading staff in Works Operations who carry out major roading works.
(d) All of the Bitumen Products Plant and all of the roading workers and their machinery from Works Operations.
(e) All of the Bitumen Products Plant, all of Works Operations and appropriate plant and support Services.
(f) Variations on the above, including the possibility of joint venture arrangements with other parties.
Two further options not involving a transfer of an undertaking are:
(g) Get out of major road works.
(h) Sell Streetworks Management to private owners while maintaining the same relationship with Works Operations.
4. CONSIDERING THE OPTIONS
No serious assessment has been done with regard to options at this stage apart from the assembly of initial information. It could be argued that the further one progresses through the options, the more we end up with a "tail wagging the dog" situation. The last option, to get out of major roading works, will have a flow on effect of destroying the viability of our Bitumen Products Plant, and probably so the remaining roading work of Works Operations. We will then have no way to influence and moderate the road contracting market. We need to achieve a result here which meets the requirements of the legislation but nonetheless, is in the best interests of the ratepayers. This will be the main focus of the Establishment unit as it progressively develops the subject based on reports from staff and appropriate consultants.
Since that time the Establishment Unit has met on four occasions, and has been supported by a staff working party which has met on a total of 10 occasions. The staff working party has retained the services of an outside business consultant to assist in the process. In association with this work a detailed study has been carried out of LATE/Business Unit working arrangements for roading in the whole Canterbury area and of the total physical work volumes in those areas. A similar study of work carried out directly by Transit New Zealand on State Highways has been done.
1 Cont'd Membership of the Establishment Unit comprises Councillors Dodge (in the Chair), Freeman and O'Rourke, John Ince (a civil engineer and director of one of the Council's subsidiary companies) and Martin Hadlee (a chartered accountant and partner in KPMG and director of several companies), Bernie O'Brien from the Amalgamated Workers Union, Jim Williamson (Director of Operations) and Mike Richardson (City Manager). In brief, the process undertaken by the Establishment Unit has been as follows: ESTABLISHMENT UNIT MEETINGS AND OPTIONS IDENTIFIED Meeting No. 1
A briefing session on what the legislation is all about, what would be necessary to comply with it, the nature of the market, benefits to the ratepayer, current relevant Council organisational elements, their type and volume of work and present degree of competitive exposure, identification of some options for transfer of an undertaking plus a brief look at each; consideration of a draft Terms of Reference. Meeting Nos 2 and 3
Confirmation of the study terms of reference and establishment of work plan and timetable. A detailed look at each of eight options in terms of a number of criteria viz legislative compliance, acceptability to Transit New Zealand, transparency of operation, maintaining and moderating the market, viability of business transferred, viability of business remaining in the Council, value for ratepayer (including the big picture view), ability to achieve option within time frame. Meeting No. 4
A discussion on arrangements and business opportunities among other local authorities within Canterbury, an extended discussion on the rationale and imperatives behind various possible choices (i.e. the philosophical what and why debate), and bringing together a decision for recommendation to the Council. The eight options considered for transfer of an undertaking were: 1. Nil transfer. 2. Transfer of the roading bitumen products undertaking, presently known as Roadstone Asphalts, plus the undertaking of tender assembly and submission, contract administration, supervision, including sub-contracts. 3. Transfer of the roading construction undertaking only from Works Operations Unit. 4. Transfer of Roadstone Asphalts etc. plus roading construction i.e. 2 and 3 combined. 5. Transfer of Roadstone Asphalts etc. plus roading construction plus our roading maintenance undertaking. 6. Transfer of Roadstone Asphalts etc. plus all construction activities (roading, drainage, water).
1 Cont'd 7. Transfer of Roadstone Asphalts, all of Works Operations, all of Plant and Building Services, some elements of Accounting Services, Personnel etc. 8. Joint Venture - Some part or all of Works Operations, Roadstone Asphalts etc. with some other company, private sector or otherwise. These options, in terms of the physical elements and business volumes involved, are summarised in Table 1 below:
1(4) 2 3 4 5 6 7 8
No. of staff 40+ 9 44 50 185 80 643 Various(
(1) 3)
Business $5.4M $4.5M $5.4M $6.1M(2 $14.7M $8,4M $43.3M Various
Volume
(per )
year)
Notes: 1. Includes staff involved in servicing of mobile plant.
2. Does not equal the sum of Option 2 and Option 3 as to add them directly would involve double counting i.e. much of the business volume of Option 2 is in fact for the activity of Option 3.
3. Varies depending upon what the joint venture arrangement may be.
4. Figures relate to the business which would no longer exist in current form. OPTION ASSESSMENT
Option 1 through 8 were presented to the Establishment Unit in series and each was discussed in some detail before moving on to the next. Significant points from the discussion on each were as follows: Option 1 - Nil Transfer In getting out of the business the Council would be turning its back on what are seen to be significant advantages that accrue from maintaining a physical presence in the market. The Works Operations Unit performs $5.4M of roading construction work per year. After paying all overhead and other costs including $0.1M direct to the Council as a return on capital, mostly associated with the hire of plant, it breaks even in this work. All this work is competitively tendered already; the margin of the accepted Works Operations (and/or Streetworks Management) tenders below the next lowest available is typically $0.3M per year. Additionally, it is considered that the presence of the Council's own work force has a significant moderating influence on the overall CCC roading construction market. This market is about $18M per year. If the general moderating effect is 1% then the value of same is $180,000 per year; if 10% then $1.8M per year. Members of the Establishment Unit felt that the moderating influence may be closer to 10% than 1%. For the benefit of the ratepayer it therefore becomes important to find a way of maintaining a physical works presence in the market. Option 2 - Roadstone Asphalts etc. The bitumen products undertaking has been tightly managed and profitable for some years. It has also been through a gradual upgrading process and holds quality assurance certification to ISO Standard 9002. Its major customer is the Works Operations Unit, although it has gradually built up business with a number of outside customers and these now comprise 30% of the plant's business.
1 Cont'd This option is compact and has been very closely studied in the financial sense. It is considered to be viable as a company operation even though there will be a downturn in business for a year or two because of changes in the CCC roading capital programme. The fact that Works Operations has a moderating influence on the roading construction market is due in significant part to the fact that it has access to "its own" bitumen products supply. Works Operations and Roadstone Asphalt have a synergistic working relationship in which each party is very dependent upon the other for its individual success and the ensuing benefit to the ratepayer. A very important issue relating to the success of this option is the absolute need for the Works Operations Unit and the new company to maintain the cost efficient and very synergistic relationship which has existed. The transfer of the undertaking of tender assembly and submission, contract administration and work supervision including sub-contracts along with associated staff resources to the new company as well as the bitumin products undertaking will form a self-contained and resourced business which, nonetheless, through commercial relationships, can still retain the valuable synergy currently existing. This option measures up positively and confidently against all the criteria considered - it complies with the legislation, it would be acceptable to Transit New Zealand, the arrangements would be transparent, it is a viable business and it leaves other parts of the CCC organisation as viable areas, it would allow moderation of the market to continue, provide value for the ratepayer and its set up is achievable within the required time frame at reasonable cost. Option 3 - Roading Construction only Construction is a very competitive business, with roading construction being particularly so especially in the Christchurch area - due of course in part to the presence of the Council's own operational activities. Compounding this situation is the seasonal nature of roading construction work, plus the future decrease in the roading construction market mentioned under Option 2. Roading construction is totally competitively tendered and has been for some years. For Works Operations to achieve its break-even targets after the normal return to the Council in its roading construction activity it depends not only upon its synergy with Roadstone Asphalts but also upon its flexibility arising from the availability of other activities within the Works Operations Unit. Roading construction on its own would be too difficult and too seasonal to be viable. Any company set up to do "roading construction only" would very soon be seeking other work as an essential step to survival, this would include competing with the remaining Works Operations Unit in some areas. That might be fine theoretically, but there is also the chance they may ultimately take each other down; and that is not what they would be there for. Option 4 - Options 2 and 3 Combined This combines the non-viable Option 3 with the viable Option 2. The combination does not address the fundamental problems with Option 3 so it is not a helpful combination. It would not comply with the legislation as it would not be likely to be a "successful business".
1 Cont'd Option 5 - Transfer of Roadstone Asphalts plus Roading Construction plus Roading Maintenance This would be a very substantial company i.e. 185 staff, business volume of $14.7M per year. This option represents a reasonably tidy and logical combination of activities. It measures up positively against a number of the criteria viz it would maintain and moderate the market, it would be acceptable to Transit New Zealand, it would be transparent. There are workload and therefore viability problems that prevail against meeting other criteria. The seasonal nature and downturn in roading construction work has already been mentioned in Option 3. A change in roading maintenance work will come as a result of further competitive tendering. Significant blocks of maintenance work have yet to be tendered. Increases in tendering of this activity are driven by the Council's policy on competitive testing and by Transit legislation. Works Operations presently carries out almost $10M of roading maintenance and related work, 45% of which is won competitively. With full competitive tendering some work will inevitably be lost; a $10M workload could become say a $7M workload. Opportunities do exist for seeking additional work outside Christchurch but these are constrained. State Highway maintenance has been fully competitively tendered for some years and is the bread and butter of national contractors backed by the oil companies. Some but not all of the adjacent local authorities have their roading maintenance locked into long term negotiated contracts. If a company was formed as per Option 5 it may be necessary to make arrangements guaranteeing certain levels of work for periods of time. Contracts negotiated pre July 1996 and continuing for a period can fit the requirements of the legislation. If the viability of Option 5 could be assured then it would comply with the legislation ("successful business"). It would, however, have a significant impact on the remainder of Works Operations, requiring substantial changes to structure and facilities, although the remainder should still be viable. It would not be possible to implement Option 5 by 30 June 1996 however. Option 5 being a much larger business than Option 2 would have larger taxation costs for the Council in the long term. This works against providing optimum value for the ratepayer. Option 6 - Transfer of Roadstone Asphalts plus all Construction Activities In principle this option is similar to Options 3 and 4 in that the activity is limited to construction. As such it has the same difficulties in terms of seasonal workloads, although possibly not to the same extent. This coupled with the typically tight nature of the construction market creates a viability problem. It should be noted that all construction work is already competitively tendered. If the company was set up to do construction only it would very soon push into the maintenance activities in order to even out workload and cash flow. This would mean competing with the remainder of Works Operations in a number of areas, with the same implications as mentioned under Option 3.
1 Cont'd
Option 7 - Transfer of Roadstone Asphalts, all of Works Operations, all of Plant and Building Services, Some Elements of Accounting Services, Personnel etc.
This is the very big option - 643 staff, $43.3M business volume. Apart from issues such as business viability and having to meet certain requirements because of Transit New Zealand legislation the consideration of this option really does test the philosophy surrounding corporatisation in general. The size alone of this option is a reason to be careful with it. There would be significant difficulties in setting up a company of this size. There will be difficulties maintaining workload with increasing competitive tendering of Council services. Any company would want to begin life with permanent staff resources below that required for any long term low point in business volumes. If the company was immediately sized to match possible future maintainable workload then it may be necessary to immediately reduce staff numbers by as much as 35%. There are some possible compensating work opportunities available with neighbouring local authorities but they would be unlikely to match what might be lost "at home". These opportunities already exist i.e. it is not necessary to be a company to pursue them. With corporatisation goes some loss of control; the company may become very busy working on everyone else's work and might lose interest in providing the extra local service which own forces are relied upon to provide. If this did happen it would tend to become worse with time. The presumed objective of having one's own forces involved in the first place would become increasingly lost. Another perspective on this control issue is to consider the danger of the company independently choosing to drop or de-emphasise a line of business which the Council really wants to maintain a significant own presence in. There is no obvious mechanism by which this large company would provide ratepayer benefits which are not already available (actually or potentially) from the present set ups. The larger company would also have a larger long term taxation liability for the Council. This large option would of course take a significant time to implement. Option 8 - Joint Venture Within this option there are a large number of possible sub-options. Following significant discussion among staff, with possible joint venture partners, and within the Establishment Unit there has emerged as yet no compelling reason to pursue such an option. Equally, some possible partners seem now less keen than they were initially. Overall it seems possible that partners need more out of us than we need out of them; or that what we might need could be achieved just as effectively without entering into a formal joint venture company. Through its operational arms and subsidiaries the Council has a real ability to moderate the markets for the benefit of the ratepayer. This ability to moderate the market is best preserved by maintaining maximum possible control of those operational arms. A joint venture company may unnecessarily dilute that control without providing a corresponding benefit to the ratepayer. 1 Cont'd
However the same discussions highlighted the need to gain new and/or maintain and enhance existing strategic business alliances for the ongoing benefit of achieving the Council's broader objectives and the Establishment unit considered further research should be undertaken in this whole area. The option now recommended does not preclude business relationships being developed with other partners. KEY CRITERIA
In assessing the options the Establishment Unit was mindful of certain key criteria, to match each option against: * Overall best value to the ratepayer.
* Maintaining and moderating the roading construction/maintenance market.
* Legislative compliance.
* Transparency of operation.
* Acceptability to Transit NZ/Transfund.
* The LATE created is a viable business.
* The functions and business aspects retained within the Council remain viable.
* Taxation issues for both the LATE and the Council.
* The Council's responsibility to staff as a good employer. PHILOSOPHY A further aspect that the Establishment Unit had regard for was the philosophical criteria - the why of it all. Included were such matters as: * The logic of change.
* Employment disruption.
* New technology.
* Possible mergers/takeovers of competitors.
* Size of LATE.
* How the business would be after 3-5 years.
* Expansion of operations into other districts, regions etc. In the wide-ranging discussions that evolved out of the options presented were matters of: * Cost of capital to the LATE.
* The market share that could be held, lost or gained.
* The business share retention.
* The effect of pending market shrinkage on Council works and the availability of Transit and other suitable works.
* The expansion of business into such activities as land subdivision/development.
* Guarantees of work for a set period from the Council - advantages/ disadvantages transparency and best value.
* Joint arrangements with other local authorities, roading contractors etc.
* Innovation, new methods and products emerging.
* Competition from other LATEs, roading contractors - trends in the market.
* The profit margins available on certain operations given market competition.
* The short/long term sustainability of competitors.
1 Cont'd
* The oil companies' position as backers of some competitors/suppliers of raw materials.
* The desirability or otherwise of mixing the profitable with non-profitable elements of an operation. The Establishment Unit has had to work through these and satisfy itself as to the application or effect of each on any undertaking to be transferred. REASONS FOR RECOMMENDATION In putting forward the recommendation below the Establishment Unit was influenced by: 1. The best value for the ratepayer. 2. The legislative compliance to maintain subsidy revenue. 3. The tight time frame available (1 July 1996). 4. The possibility of further changes of direction by central Government on LATE legislation. 4. A viable business created in its own right. 5. Minimal taxation implications for the Council. 6. Does not preclude future expansion and development of the LATE. 7. Minimal disruption to the balance of the organisation. 8. The requirements of Transit NZ/Transfund are satisfied. 9. Enables continued moderation of the roading market in Christchurch City. 10. Retains plant and other resources within the Council to be available for emergencies such as rural fire fighting, floods etc. 11. Maintains a focus on Christchurch City's works requirements to the benefit of its ratepayers. STATUS OF THE RECOMMENDATIONS The recommendations of this report are the start of a process which will need to involve the public at a later stage. When the proposed Establishment Plan is reported to the Council in April the Council may either accept it, or reject it, or refer it back. If the draft Establishment Plan is accepted then it needs to be publicly notified. If it is rejected it would require the whole process to go into a public consultation process. In the event of the Council wanting to reject the recommendation, the Establishment Unit would respectfully suggest that the matter, rather than being formally rejected, be referred back to the Establishment Committee for further investigation. 1 Cont'd
NEXT STEPS The work of the Establishment Unit is not completed by the recommendations now put forward.
Attention must immediately be turned to the preparation of the actual establishment plan. This is expected to be brought to the Council at its April meeting.
Other activities that the Establishment Unit will consider at future meetings are the valuation of the undertaking and price to be paid, debt securities, constitution of the company and Statement of Corporate Intent, the transfer of the undertaking and its employees. Progress on these will be reported progressively. An early task will be the appointment of directors for the new company (and a manager) so that price negotiations can begin and details and methodology for the transfer can be confirmed. When the establishment plan is presented to the Council in April an attendant recommendation will be that (3) directors be appointed. Recommendation: The Establishment Unit reached unanimous agreement on an appropriate course of action and now recommends to the Council as follows: 1. That the Council form a new roading LATE. 2. That by 30 June 1996 there be transferred to the new roading LATE an undertaking which comprises the bitumen products undertaking and associated staff, plus the undertaking of tender assembly and submission, contract administration and work supervision including sub-contracts and appropriate associated staff resources to the new company. (This is Option 2 from the options list.) 3. That, on the basis of 1 and 2 above being accepted by the Council, the Establishment Unit report to the April 1996 Council meeting with an establishment plan. 4. That subject to the acceptability of the new roading LATE being confirmed with Transit New Zealand that no further consideration be given to transferring other assets into the proposed LATE. 5. That the Establishment Unit immediately consider possible joint ventures and/or strategic alliances between the roading LATE and other parties and focus on business strategies aimed at maximising its success and the Council's wider objectives. Chairman's
Recommendation: That the recommendation of the Establishment Unit be confirmed.