How can the construction industry break its fall?
Design and build contracts are squeezing the life out of construction firms as they fight a losing battle to balance winning work and making a profit in what many have termed a race to the bottom. Diversification and involving contractors earlier in the process could stop the slide.
Chris McGoff, director of construction firm McGoff Group, said main contractors should be involved from the planning stage so they could have more say in the direction of a project.
“It is so important for main contractors to lead the process from the top. If not, if you get something wrong, that could cost you 2% of your margin.”
McGoff was critical of cost consultants who he said were sometimes “miles off” in terms of their estimations of what a project will cost as well as being overly reliant on “stale data”.
On one occasion, his firm calculated that a job would cost £16m whereas the client-appointed cost consultant came back with a figure £2m lower.
“One of the other parties that tendered for the job went bust. The market is very competitive and a lot of the time clients are being advised inappropriately by cost consultants who are setting unrealistic expectations on pricing,” he said.
Diversify to survive
McGoff explained that his construction firm doesn’t tender for work that often anymore. Rather that it is fed by self-generated work such as building out schemes for New Care, McGoff’s care home development business.
He said this diversification, and being able to generate work in-house, were key to avoiding the pitfalls of design and build but appreciated that not all companies were equipped to do this.
“North West contractors that enter into that race to the bottom do it at their own peril,” McGoff said.
The impending collapse of Cruden Construction, which has signed a notice to appoint KPMG as administrator, is an all too familiar story for the industry.
Since December 2018, several high-profile names in North West construction have gone to the wall. These included Forrest, Worthington Construction, CPUK, Bardsley, Pochin’s, and Harry Fairclough.
The reaction is typically sadness, tempered with a rueful acceptance of something inevitable. Shock is way down on the list of emotions these days.
Zoe Brooke, director of Widnes-based construction firm Whitfield Brown, and founder of the Save Construction Initiative, is angry.
“It is absolutely devastating. We are at a critical point now.”
Brooke has called for Government intervention in order to help the sector but admits that the process of design and build is largely to blame for the collapse of some of the North West’s most well-established contractors.
Design and build is when a developer, often guided by a cost consultant, sets a fixed price for the construction of a project, transferring the financial risk to the contractor.
In order to win contracts, construction firms will bid low, narrowing profit margins, often to less than 5%.
As profit margins constrict, so too does the margin for error. Even the smallest mishap could plunge a firm into the red.
CPUK collapsed owing £11m to creditors, largely due to a single problem job, Primesite Developments’ £40m The Rise scheme, which was subject to delays.
Even while still operating, the narrow profit margins inflicted by design and build are reflected in firms’ financial results.
Cruden reported an operating loss of £2.2m despite a £38m turnover in 2018. The previous year, Bardsley turned over £68m but made a profit of just over £1m.
Pochin’s made a £6.2m loss after tax on a turnover of £50.5m, according to its most recent accounts for the year to March 2018.
“People refer to it as a race to the bottom. I call it a self-harm cycle. We are all in a state of desperation to win work,” Brooke said.
Having won a contract with a low bid, the contractor will then set about planning how to recoup money during the build, Brooke explained.
By doing this, contractors are effectively backing themselves into a corner, risking the financial health of the company on the chance that it will be able to claw back money and make a profit.
The process of pricing a job can take up to four weeks and cost around £50,000 and not winning a tender, that so many resources have gone towards, creates increasing pressure to win the next one, Brooke said.
“We need a change in behaviour. People have got into the aggressive mindset that the lowest tender should always win,” she added.
Stuart Stead, head of property and construction at accountancy practice Cowgills, said there was an obsession among developers with “getting the work done cheaply”.
He said this obsession meant that contractors have little room for manoeuvre and two- or three-week delays can have a drastic impact on a firm’s finances.
“For a £10m job, the profit margin could be as low as 2%,” he said, adding that sometimes contractors will take on a job knowing it won’t make a profit “just for the turnover”.
“We need a seismic shift in culture. The cheapest price mentality throws out the dynamic of a relationship between client and contractor.
“There needs to be more collaboration between client and contractor to build up trust,” he said.