A failure, but what kind?

I was more focused on my barbecuing than the TV1 newscast last night, but then something caught my attention:

Calls are growing for better legal protection for companies affected by other firms’ receiverships.

But in the wake of the Mainzeal Property and Construction collapse, the Government says there is no evidence new laws are needed.

The report also used the words ‘market failure’.

Mainzeal has gone into receivership, creating headaches for subcontractors. Some of their tools and equipment are locked up, and they are owed hundreds of thousands if not millions of dollars.

Clearly, it hasn’t gone right. It’s a failure, but what kind of failure?

The initial reports pinned the blame on two things, leaky buildings and supply chain problems.

• Leaky buildings — Mainzeal explained/complained that the architects and builders who contributed to the leaky building problems have all closed up shop, so Mainzeal was left as the ‘last man standing’. I have no sympathy for the company on this score. The building industry is organised as a lot of different companies contracting and subcontracting to each other. They could, if they wanted, organise into a few large vertically integrated companies that provide services from design through to completion, with all the chippies, sparkies, painters, scaffolding, etc. inside a single company. They find it better — presumably for risk minimisation purposes — not to do that. Mostly, it works. Sometimes — as in the case of leaky buildings — an expensive failure requires a fall guy.
• Supply chain problems — Mainzeal made business decisions about its supply chain. It chose to work with new suppliers, presumably to lower costs and increase its profits. That’s what the business is supposed to do. It didn’t work out — there were problems, it cost money, the profits didn’t eventuate. Yeah, well, that happens. Happens to chip shops, happens to large construction companies.

Mainzeal has some business problems. They tried a business model that, as it turned out, didn’t work under circumstances. They tried new supply chains that, as it turned out, didn’t deliver the goods. It looks like a simple case of trial and error. Error — failure — is part of the evolutionary process that a market economy allows.

One failure that is part of this episode is a regulatory failure. Leaky buildings are a complex problem and there is enough blame to go around. Building regulations contributed to that failure. First, new products and methods were permitted. Secondly, councils ‘signed off’ on the buildings, which buyers took to be warranties of fitness for purpose but councils now insist were not. Consumers — building buyers — were taking on more risk than they realised, because they did not understand the nature of the products or the council approval. Without the regulations — with a more ‘buyer beware’ approach — we might have seen either more conservative building techniques or more insistence on bonds or insurance.

The new regulations fostered innovation in the building industry, which is generally desirable. It also increased the risk without insuring against it. In the end, individual building owners have borne much of the costs. In addition, more established companies like Mainzeal have also taken a hit.

Faulty regulation played a part in Mainzeal’s failure, but so did the company’s and the industry’s business decisions. What’s not obvious is any clear market failure. The saying goes that ‘failure is an orphan’; we should do a DNA test on this one to understand its parentage.