Welcome to the new normal
After recession comes recovery — doesn’t it? Except that three and a half demoralising years since the credit crunch, there’s no sign of recovery. Instead, we are in the New Normal, an unfamiliar territory where workloads and contract sizes have shrunk, but the skills needed to deliver them have risen; client expectations are up while the prices they’re paying are down.
“People have come to terms with the fact that we’re in a new world, it’s not a short-term deal and things have changed,” says Peter Jacobs FCIOB, managing director for the London region at Morgan Sindall Construction.
The New Normal is winning work at margins so thin that one wrong move could pitch the project into a loss. Clients are achieving “more for less”, with out-turn costs wiping out the construction price inflation of the boom years and more. It’s working on smaller contract sizes — a Construction News/Glenigan survey found that the average contract size fell from £14m in 2008 to £8.7m in 2011. And it’s the sight of major national names on tender lists for six-figure contracts — and now being joined by work-hungry contractors from Ireland.
The conundrum of the New Normal is that the work pipeline has by no means dried up: it’s just narrowed and moving at a slower pace. “It’s a different type of economy — there’s still an ageing population, school places need to be delivered, the demand for social housing is still high. It’s about efficiency, effectiveness and unlocking value,” says Graham Kean, head of public at EC Harris. “The projects are about refurbishment, remodelling and adapting to reduce operating costs.” In other words, contracts that are lower in value, but more demanding in terms of skills, labour and resources.
Business as usual
So how is the construction sector adapting? Clearly, different businesses are experiencing it in different ways.
For the premier league players, insulated by major projects such as Crossrail and the remaining BSF and public sector framework deals, there is possibly a greater sense of business as usual. It’s also clear that New Normal in London and the south-east is more comfortable than it is in the midlands and the north — analysis from PriceWaterhouseCoopers show a 5% decrease in construction firms going bust in London in 2011 compared to 2010, but a 9% increase elsewhere.
But for the broad middle ground of the construction industry, struggling to match their workload to the new realities, the New Normal has ushered in a very different way of doing business.
“We started referring to the new reality about two years ago,” says Mark Beard FCIOB, managing director of Beard Construction. “What happened in 2003 to 2007 was abnormal and now we’ve got to trade successfully in today’s climate. The skill is in recognising that and acting quickly.” At Beard, that has meant switching focus to smaller and medium-sized projects to maintain the order book.
Midlands contractor Shaylor Group is being broad-minded about what it takes on: project values range from £1,000 to £15m. “We made a strategic decision to concentrate on clients whose connection with the construction industry was through the revenue account, not capital projects — clients looking to refurbish or maintain their current assets,” says Shaylor Construction framework director Martin Chambers PPCIOB. “So project values automatically became smaller. Now it’s £3m, a few years ago it was £7m.”
Typically, construction companies are leaner, tighter operations, with their cost base better matched to their income.
Phil Westerman, head of construction at finance and business adviser Grant Thornton, points out that construction has historically struggled with low margins, but the struggle was harder than it should have been.
“Businesses that used to make 6-7% in the good years should really have been making 8-9%, but central costs got out of control. In the credit crunch, business stopped growing, and there was a smaller revenue pot to cover overheads,” says Westerman. “If they’ve re-based their overhead bases they should potentially make more money in the future — and not aim to grow too fast again.”
Realising efficiency savings
Contractor GB Building Solutions “battened down the hatches”, reducing costs by measures such as switching regional offices from rental to owner-occupation, says chairman Martin Smout. “We’re a more efficient company — overheads have fallen from £12m to £7m,” he says. At Baxall Construction, managing director Malcolm Clarke says the company is now benefitting from the IT system it invested in during the boom years — but only yielded real efficiency savings when management refocused on quality management in the New Normal.
Many contractors acknowledge that the crisis has prompted them to excise the financial flab that crept in when the bottom line just kept growing. “When you’re busy, it’s hard to concentrate on all the details that create total cost efficiency,” acknowledges Gary Sullivan of construction logistics and services provider Wilson James. “When you’re less busy, you streamline HR and payroll issues, and recruit staff to project manage internal issues like IT.”
In terms of project delivery, many contractors describe how they’ve upped their game in the New Normal, modifying designs for economy and pragmatism; using their expertise on supply chains and logistics; project managing extraneous costs and carbon out of the project. “Margins are rising slightly and the bottom line will improve, but not because of any change in tender margins — the reason for the change is doing the stuff we were doing better and leaner,” says Martin Chambers of Shaylor Group.
Other contractors have adapted to the tougher conditions by offering clients a defect-free service or sustainability expertise. “We’re building a reputation for delivering to a higher standard. Delivering projects on time, to decent quality and almost snag free is part of the new reality,” says Mark Beard.
“A lot of the things that were aspirational a few years ago are now expected,” adds Peter Jacobs at Morgan Sindall. “Three years ago you could have had a nice glossy plan about your sustainability standards — now you need evidence of what you’ve achieved.”
At GB Building Solutions, Martin Smout says the company is working harder at community engagement, particularly on its framework contracts. “We add as much value as we can, in bricks and mortar, or in local employment training, or working with local charities. We try to put something back into communities, not bleed them dry.”
So can contractors that have managed to survive into 2012 be sure of having their signs on site hoardings in 2013 and beyond? Grant Thornton’s Westerman believes it is unlikely that another major name will disappear from the construction landscape. “Even if their margins have declined, [the largest players] have got security of income — and security that the end-user will be able to pay and can look forward with confidence.”
Jonathan Hook at PwC agrees: “I wouldn’t expect any major players to come unstuck, they’re generally quite diversified and often in overseas markets that are actually quite strong.”
But that’s not to say we’ve seen the end of construction insolvencies. ”The people who are vulnerable are some of the regional players, focused on public sector work, or smaller contractors more exposed to property developers,” Westerman says. As cash reserves dwindle and long-running contracts reach financial close, these SME contractors could yet fail if income from new, smaller projects doesn’t cover their overheads.
Even larger contractors have to tread carefully. The business development director at one major contractor says it is winding down several contracts in the £100m+ bracket that were signed three to four years ago, and their replacements are smaller in size and value. “There’s nothing of that size to bid for left,” says the director. “Now we’ve moved down the scale, projects get off the ground and complete faster, so the work in hand doesn’t take us as far forward. This year is critical, this is when we have to prove that we really have changed our game plan.”
No room to manoeuvre
And in the New Normal, threats could still come from other quarters. Hook says that Tier 1 contractors that improved their own margins at the expense of the sub-contractors may find they have no more room to manoeuvre: “There’s a limit to how much you can continue to squeeze the supply chain.”
Westerman also warns contractors that for the Inland Revenue, it’s business as usual. “Businesses that have had to go through pleading and begging with HMRC [to delay tax payments] are now high on its radar,” he says. “People might find they’ve used up all their credits, and there could be fall-out if they get into default again.”
The rising expectations of clients will force further adaptive changes, and the firms that fail to respond will leave themselves vulnerable. For instance, the focus on BIM and offsite manufacture will create expertise and take cost out of the supply chain. “But that requires up-front investment, and only the stronger players are able to make that investment,” points out PwC’s Hook.
Glimmers of optimism
The business conditions of the New Normal are likely to prevail throughout 2012-13 or longer — until confidence and a revitalised housing market can offset the combined effects of public sector spending controls, high unemployment, and low wage inflation. “I don’t see any signs of relief. Overall, I think times are going to be pretty tough,” says Hook. But he also says government stimulus packages are starting to have an effect on house building, and sees glimmers of optimism. “As we approach the next election, we will probably see government release the purse strings and we might see some growth strategies.”
Also, major capital projects will eventually return, says Graham Kean at EC Harris. “In two years, I think we’ll see a change, the emergence of a new model of PFI [will address pent up demand].”
The New Normal presents the challenge of delivering more, smaller-value projects — and backing them up with increased project management skills and business savviness. But there is some cause for optimisim. “In a strange way, the fact that the recession has gone on longer than expected means that the improvements the industry has made can be embedded. In the recessions of the early 80s and 90s, good practice wasn’t really embedded,” says Mark Beard.
The implications of this is that businesses that successfully adapt to the New Normal should end up leaner, fitter, and more profitable – and better placed to benefit when economic confidence eventually returns.
It’s normal to…
… deliver projects more efficiently…
A flatlining economy, in which clients routinely expect “more for less”, has achieved what two decades of government initiatives and exhortations failed to do: broadly speaking to deliver projects at cut-throat prices and still make a margin, contractors are embracing lean thinking, squeezing out waste and reducing rework to a minimum.
From the perspective of 2012 and its new emphasis on efficiency, some of the out-turn costs racked up in 2008-10 begin to
look distinctly off-colour. According to EC Harris, average per m2 out-turn costs in education projects fell from £2,700 in 2009/10 to £1,400 in 2011.
Martin Chambers PPCIOB, frameworks director at Shaylor Construction, reports that prices are back at 2005 levels, wiping out the 10-15% cost inflation of 2005-08. “I’d say we are 15% more efficient, we use more off-site, we take more waste out, we’re better at getting it right first time,” he says.
At Morgan Sindall, Peter Jacobs says he’s aware of far less waste in the supply chain. “The best of the specialists [trade contractors] have upped their game a lot over the last few years, say by 20%. A lot of the old adversarial stuff has been driven out of the supply chain.”
But some of the improvements in efficiency can be found closer to home. “Everyone’s working a lot harder than they were. But [after redundancies] you’re left with the best people in the business, so you manage to get more work done,” says Phil Wilding at Wilding & Butler.
… to outsource
When the credit crunch first hit, many contractors made cuts to their central admin and support functions, such as HR, finance and tendering support. Now that many have stabilised their businesses, they’re looking to outsource rather than rebuilding in-house teams.
“Now, in picking up work, we’ve outsourced some support roles,” says Malcolm Clarke MCIOB, managing director at Baxall Construction of Kent. “We now have an external consultant updating the website and assisting with marketing and bid-writing, releasing managers to do other things.”
Contracts and risk management consultant CR Management offers companies training on winning work then making the best of the work they have won. Partner Jason Farnell says contractors have become more creative: “Following redundancies, companies have lost a bit of their history and cultural identity, the sense of ‘this is how we’ve always done it’. They’re more open, more creative. If you want to get the best out of people, you’ve got to let them think and produce solutions.”
… to have fewer disputes
As the credit crunch started to bite, a spike in legal proceedings was expected as contractors looked to shore up their finances by resorting to the courts. That spike never materialised: according to research from Glasgow Caledonia University, the number of construction adjudications broadly halved between 2001 and 2010. That’s not to say the courts aren’t busy, but a large part of the caseload relates to insolvencies and their aftermath.
Simon Tolson of law firm Fenwick Elliott, chair of the Technology and Construction Solicitors Association, says there has been a shift in the way construction solicitors operate. “Clients are using lawyers to advise throughout a project, not ringing them up because they’ve decided to go to court. The legal market has matured and met that demand.”
CR Management used to advise clients on “cold cases”: projects where the team had dispersed and the issues were fading from memory. Now, all its cases relate to projects still on site. “There’s more willingness to deal with issues earlier, to get the final account so we’re seeing far fewer disputes,” says partner Jason Farnell. “People want to negotiate, want to get to an agreed position and move on. It’s about resources and being realistic, and it contributes to a greater efficiency.”
And where contractors that have tendered uneconomically low might once have attempted to improve the final position through legal action, the norm now is to renegotiate. “Some people we’ve worked with have gone back to the drawing board, and customers have recognised this to some degree,” says Phil Westerman at Grant Thornton.
…to get discouraged
For owner-managers in SMEs, the New Normal often means longer hours for less reward — both financial and psychological. “Working life’s not as enjoyable as it was. When you go to events and speak to other people in the industry — the architects, engineers and surveyors — it can be quite demotivating just talking about it,” one SME director admits.
For employees, job insecurity remains high. According to the quarterly Employee Engagement survey from the Chartered Institute of Personnel and Development, 21% of employees across the economy felt their jobs were under threat in Q4 2011, slightly up on the 20% recorded in Q3 2011. Pay freezes are still overall the norm, in Q4 2011, 75% of public sector workers said their salaries were still frozen, while in the private sector 43% of staff were affected.
Ben Willmott, head of public policy at the CIPD, warns that the combination of job insecurity and pay freezes could be harmful to employers. “There is the risk of higher levels of stress and absence, and reduced likelihood of innovation — you won’t get ideas coming up from the frontline or good intelligence about the marketplace,” he says.
If a boost to pay packets isn’t possible, Willmott advises employers to offer other benefits, such as flexible working arrangements and childcare vouchers.
… but normal to look ahead with optimism
After experiencing redundancies and recruitment freezes, several of the companies CM spoke to for this article are now planning to recruit again in 2012. And there is evidence that jobs are filtering back on to the market, as companies re-hire some of the skills they were forced to cut. “We’ve noticed a pick up in the number of vacancies we’ve registered in most geographical areas, but we’re not back to the levels of 2006-08. Some regions are doing better than others – the south, South West, London and East Anglia are the areas where people are investing,” says Greg Lettington, director of Hays Construction and Property for the West Midlands.
Some companies are feeling confident enough to consider small pay rises and reintroduce bonus schemes. At Shaylor Group for instance, a one-year pay freeze is being followed by a rise for 2011/12.
And while we still hear news of rising unemployment, flatlining GDP growth and the impact of public sector cuts, the best strategy could be to mentally tune it out. “There’s no point in worrying ourselves about whether Network Rail is going to do a big infrastructure project, or that homeowners aren’t doing small domestic projects, because we’re not in that market,” says Malcolm Clarke of Baxall Construction. ”If you listen to all the news, you can become very negative. But you have to deal with what’s in front of you, and let other people worry about the rest.”
…to struggle to balance the books
Low-margin work presents plenty of problems for contractors. Wrong moves that might have been lost in the overall picture can now have a serious impact on the final account or a contractor’s chances of winning the next contract.
In the New Normal refurbishment and maintenance-led economy, recovery of overheads is more pressing. Compared to new-build projects, the difference between a £1m job and a £2m job is more likely to be in labour than components and materials. Even if contractors are foot-sure and efficient, it’s harder to cover overheads from a smaller £1m job. “It’s a struggle to win the work, then sometimes we find there’s just no profit,” says one contractor.
Contractors are also keeping an eye on clients’ ability to pay. Gary Sullivan, managing director of Wilson James, which offers logistics services to contractors, has walked away from projects where there was doubt over financing. “With a large payroll, we’ve had to be very conscientious about cash flow,” says Sullivan. “We took a view we’d only work in areas where we knew we would be paid.”
Meanwhile, contractors know that taking lower-value work can be a risk if income ever fails to cover their obligations. “Contractors can survive a while beyond the decisions they make to keep going. But sooner or later they’ll catch up with you,” says GB Building Solutions’ Martin Smout.
… to work harder to win work
Tendering — and finding projects to tender for — is typically taking up far more management time than previously. “It takes a lot more management time in terms of finding out what’s available and getting on the lists,” says Steve Burditt, managing director of contractor Steele & Bray in Northampton. “We’re probably working harder and doing less.”
Hampshire-based Wilding & Butler says its strike rate has dropped. “Previously, we’d expect to win one in three jobs, or one in four — now it’s more like one in eight. We’re having to look at every possible avenue when pricing a tender, finding the key to carrying out a job. We’re being a lot smarter when it comes to tendering. At this level, one wrong move and you’ve racked up a loss,” says director Phil Wilding.
The bags packed for European property showcase MIPIM earlier this month were heavily weighed down with expectations. “Even a week in the south of France is far more serious and business focused,” says Peter Jacobs at Morgan Sindall. “It’s a good example of the New Normal. Rather than R&R, everyone is now focused on building relationships.”
Networking and marketing has also changed. Steve Kettle runs Networking in the City, which organises Curry Club events for the construction and property sector in eight locations, including London, Sheffield and Leeds. “Previously, you might have had the business development managers attending, now, you see fairly high powered people, the business owners themselves,” he says.