Trevor Drury FCIOB, managing director of contracts consultancy Morecraft Drury, on the backroom problems that lead to boardroom upsets.
In the last couple of weeks a number of senior executives have left their current firms amidst profit warnings and reported losses. Is this a case of the effects of the recession starting to catch up and bite as costs have increased?
According to the Building Cost Information Service, tender prices are going up: they’re forecast to rise 5.6% between Q2 2014 and Q2 2015. But building costs, material prices and nationally-negotiated labour rates are all going up too. Meanwhile, construction salaries are also on a dramatic rise after years in the doldrums. According to the Hays contractors’ salary survey reported in Building on 3 October, average salaries over the past 12 months have increased by 7.4% with the Office of National Statistics showing earnings across the whole industry rose 4%.
If work won in recession was not procured back-to-back with subcontracts and supply agreements at the time of winning the work, contractors will now be suffering from supplier and subcontract price inflation as the demand for resources starts to outstrip the resources available.
Against this backdrop it is not surprising that many main contractors are finding it difficult to maintain profit levels or even calculate the full effects of these increases on projects secured in the down-turn, hence the three profits warnings in five months from Balfour Beatty, plus ISG, Royal BAM Group and Sir Robert McAlpine all posting construction losses. The worrying issue is that the trend for cost increases is continuing upwards.
Other contractors with successful and significant housing subsidiaries have been able to weather the storm better, due to the boom in housing prices in the last couple of years.
If work won in recession was not procured back-to-back with sub-contracts and supply agreements at the time of winning the work, contractors will now be suffering from supplier and sub-contract price inflation as the demand for resources starts to outstrip the resources available. At the very least, suppliers and sub-contractors can pick and choose contracts more readily than a year or two ago and price jobs less aggressively as more work becomes available.
But even if main contractors managed to procure subcontractors and suppliers back-to-back early in the procurement stage, there is no guarantee that those subcontractors will ultimately turn up or that suppliers would guarantee against price rises. As commentators have said prior to coming out of recession, the challenge will be for main contractors to remain profitable as we come out of recession. Large, long duration projects provide estimators and contractors’ directors with the difficulty of including a sufficient risk budget for future price increases at a time when they needed to secure workload in a very competitive market. Perhaps they were also taking on less attractive and high risk projects at the time.
The challenge for contractors and their commercial departments is to forecast the out-turn cost and value to the business from that project. In my contracting days, as a contractors’ quantity surveyor, much time was spent on the monthly Cost Value Reconciliation trying to calculate subcontract liabilities, which is not easy when a project is in delay with subcontractors submitting claims in varying degrees of detail and trying to establish the fact from the fiction presented in such claims.
Today, many contractors’ surveyors will not have the knowledge to properly ascertain the subcontractors’ contractual entitlement or their own up the line to the employer. This is where claims and forensic specialists are required and presumably why Balfour Beatty have brought in one of the “big four” management consultants which will hopefully have claims consultants and quantity surveyors amongst their ranks. Valuing construction project’s work in progress and liabilities is rather different to management accounts, profit and loss statements and balance sheets.
Eventually, the main contractors will complete these old recession won projects and replace them with new projects with hopefully better margins, but the lack of skilled and educated resources, as a consequence of a reduction in training and senior experienced people leaving the industry, remains a risk for many contractors – and we may see more well-known names using the exit door from the industry’s boardrooms.
Trevor Drury FRICS FCIOB MCIArb is managing director of commercial, management and construction consultant Morecraft Drury
The City do not understand the construction industry which is so influenced by Government providing make work projects as and when they feel like it Perhaps the British Construction industry should look at the North Americian model where subcontractors are set up to provide pricing at tender time and can provide performance bonding.