Serco shares plunge after it's forced to backtrack on supplier squeeze

A bad weekend for Serco: yesterday it emerged that the FTSE 100 outsourcer had sent a letter to nearly 200 of its suppliers demanding a 2.5% cash refund for this year, to help it hit the Government’s cost-cutting targets. This caused widespread outrage, not least with the Government itself, which just so happens to be Serco’s biggest customer. Now the latter’s been forced into a rather embarrassing about-face, promising not to squeeze its suppliers after all. The episode has clearly been badly handled (and wiped £180m off its share price). But was its only mistake doing this in public?

It’s true that the tone of the letter – sent by FD Andrew Jenner – was pretty aggressive (‘brutal’, said one supplier quoted by the Telegraph, which had the scoop yesterday). In it, Serco asks for a rebate of 2.5% on the amount it’s spending with them in 2010, followed by a thinly veiled threat; Jenner said their response would ‘indicate your commitment to our partnership but will also be something I will seriously consider in our working relationship as Serco continues to grow’. In other words: if you want to keep working with us, give us some cash back.

This rather blatant strong-arming went down like a lead balloon with the Government – not least since Serco had apparently promised that the big cost savings demanded by the Coalition wouldn’t come from its supply chain. Cabinet Office minister Francis Maude apparently called Serco in to explain itself – and as you might expect after an angry conversation with its biggest customer, this morning Serco issued a slightly shamefaced apology. Apparently its plans have ‘evolved’, so it will no longer be seeking contributions from its suppliers – and it apologised ‘unreservedly for the concern that this has caused’.

Hand-wringing aside, it’s worth pointing out that what Serco was trying to do here is no different to what most big companies have been doing lately, or even to what the Government itself is doing – it’s having to cut costs, so it’s asking its suppliers to share some of the burden (not unreasonable in itself, you might argue). Even when times are good, suppliers expect to be squeezed hard on price when they’re negotiating with big companies. It’s just that most of them put the thumb-screws on behind closed doors, rather than by letter.

Unfortunately, this just adds to the perception that big companies are refusing to take their medicine, and instead are passing on the pain to their smaller suppliers (a point emphasised by the pay levels for senior execs in big public companies, as Robert Peston points out today).

So it’s no wonder Serco’s share price has slumped by 6% this morning. Since Government work is so important to the company, investors are worried that the reputational damage from this little episode will hurt its chances of winning future bids (not least because opportunistic rivals have been quick to trumpet their own supplier-friendly practices). And if it won’t be finding some savings from suppliers, there’s a good chance it may have to revise its own margins downwards. Serco’s a company that’s extremely well-regarded by its peers, despite its low public profile – but it’s learned a hard lesson here, it seems.