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How clients can ensure success in a high risk, contractor led market

1st October 2015

Despite national trends, the London and the South East Construction market grows...

National economic indicators suggest that the Construction market is cooling.  Construction output dipped by 0.7% in July 2015 compared to July 2014, the first year-on-year fall recorded in over two years.  Despite this, the London and South East Construction markets continue to see sustained growth. 

In London and the South East, the majority of contractors throughout the supply chain are at full capacity, allowing them to be selective in which opportunities they pursue.  This selectivity has led to a continued rise in building cost inflation and tender price inflation.  In fact, the Building Cost Information Service (BCIS) of the Royal Institution of Chartered Surveyors is reporting a forecast Tender price mean average increase of 6.5% from Q4 2014 to Q4 2015.

These cost increases are being driven by a combination of client demand and staff and labour shortages.  There are now more private residential units under construction in the capital than there have been for the last two decades (Estates Gazette reports a figure close to 36,000 units). To meet the projected demand, the Construction Industry Training Board (CITB) believes an additional 220,000 new jobs are required over the next five years. In addition to this, increased client demand has led the BCIS and leading cost consultancies to forecast year on year increases of circa 5% over the next 4 years. But with this positive growth, challenges have emerged…

An influx of work has seen the supply chain change

Due to a shortage in skilled labour and inflation in material costs, the supply chain is changing. We are experiencing above national forecast inflation increases from all trades. The skills shortage is driving up the cost of labour driven intensive trades, and the consolidation in the supplier market is driving cost further. Subcontractors, now in demand, are being as selective as main contractors in which opportunities they price. Pressures which did not previously exist are affecting services and contractors as varied as brick manufacturing, lift installers, cladding companies and M&E firms. 

 

Low interest rates are currently mitigating the financial pressure on construction firms in financial difficulty.  Whilst there are a relatively low number of insolvencies, there are a number of bad or ‘zombie’ construction firms in the market, who normally would have been forced into some form of insolvency by now. These firms are still likely to be tendering at a loss to win work.  In addition, the current state of the industry means that it is currently very easy for someone with little business acumen to start up a multi million pound business. There is a real risk that some smaller or less experienced companies will look to fill the gap in the market by upsizing.  They may take on greater design responsibility and run into cash flow problems, increasing the risk of poor quality delivery and the risk of insolvency. Furthermore, though the Banks are starting to recover, they continue to take a very risk adverse approach. If they are financing an organisation ‘on the brink’ that needs additional finance, there is a very real possibility they may decide to use this as an opportunity to withdraw their services, forcing the company to seek finance elsewhere and further increasing the insolvency risk.

Using clear procurement strategies to secure success and mitigate risk

In order to mitigate against these market trends, the design solution, combined with an attractive procurement strategy, is ever more important in securing success and mitigating risk. The preference to get the best price in the market by adopting a single stage route is no longer available in the current market. The key challenge for project procurement now is for clients to promote their projects as the most attractive proposition in an increasingly selective bidding market.

We believe setting a 2 stage or open book negotiation strategy and running the process with regular and constructive dialogue though out the tender process is critical to success. We have found that a collaborative procurement strategy where the main contractors and supply chain can sensibly negotiate the risk though collaborative dialogue is generating the best results.  Main contractors and their supply chain will quickly walk away from an opportunity that they consider carries too much risk.

When forming your procurement strategy, we consider the following things the most critical elements to consider in the current market environment:

  1. Clearly define the project using robust documentation.
  2. Establish a strong design team.
  3. Maintain regular client engagement throughout the supply chain, in particular with specialist sub-contractors.
  4. Ensure contract and payment terms are market facing.
  5. Robust pre-qualification to sell the project and get early contractor interest.
  6. Keep engaged with the contractor market, just in case contractors’ positions change.
  7. De-risk the project as far as possible and do not transfer unreasonable levels of risk to the contractor.
  8. Leverage consultant’s relationships with contractors.

Conclusion

Despite national trends, the London and South East Construction markets continue to see sustained growth. This growth has led to a variety of market conditions placing contractors in a position of power and increasing risk on the part of the client. In order to mitigate against risk and ensure effective procurement, the development of a good quality, robust and buildable design that provides an attractive risk profile to the supply chain is necessary. Aligning the design deliverables with the procurement strategy and construction methodology is essential to de-risk a project and to present it as an attractive proposition to potential contractors. It has never been more important to build a collaborative team, and we believe this Team building starts during the pre-qualification process. Thus, it is vital to maintain the same level of interaction, dialogue and transparency throughout the procurement process and the project delivery stages.

 

 John Godden is director of cost management in Capita’s property and infrastructure business.

 

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