A perfect storm?
Cat Griffiths-Williams, CEO of CEWales took the opportunity to explain to the Chief Economist of the Bank of England the perfect storm the construction industry is navigating right now. Here’s what she said.
A strength of CEWale is our ability to influence the influencers. At a private dinner with Huw Pill, Bank of England Chief Economist I was able to share the anecdotal ‘on the ground’ narrative. This is what I told him.
There are multiple factors in play in the economic landscape of the Built Environment. Many companies (main and subcontract) have had to use any ‘reserves’ they had built up in recent years to continue trading throughout the COVID pandemic. Furlough did help but it didn’t solve all aspects. Some companies had projects put ‘on hold,’ others continued to work but at a reduced efficiency and at an output rate that has led to contract over runs. The commercial risks associated with these have to be borne by contractors and subcontractors – after all contractual conditions may not allow for reimbursement.
Companies hoped that there would be an abundance of stalled projects coming to market that will replenish order books and allow for reserves to be built up through business resiliency. This has not occurred for many companies of all sizes. These companies are now trying to re-establish reserves and build resiliency back into their businesses, with great difficulty, to continue trading in an ever-changing economic landscape
Inflationary pressures on materials and fuel are creating risk. There remain high tendering opportunities, but they are poorly defined. So how do we deal with the inflationary effects on contracts. This is against a background of fairly stable conditions over the last twenty or so years, where contractors were prepared to take the risk and offer fixed price contracts.
That is difficult to do in the current environment and many contractors and suppliers are understandably reluctant to take this risk. This is even the case where clients are prepared to pay for the risk, as it’s almost impossible to forecast what is likely to be. The solution is for clients to take the risk themselves through either fluctuating contracts, or regular price reviews through the contract. Pressures also come from unrealistic client budgets and risk transfer expectations that are limiting returns. There’s a sense that suppliers are loading many tenders with high-risk allocations which increases tender prices. But equally, this problem also demonstrates that a collaborative approach with shared risk management would help give better value for money.
One key aspect we are seeing across a range of Clients, from local authorities to TfW, is the need to source alternative forms of funding. These include Levelling Up funding, and other sources such as Restoring our Railways, not least because of the missing EU funding after Brexit.
On a wider theme there has been recent discussion on the Barnett consequential payments and financial benefit seen in Wales from HS2, which is not commensurate with Scotland as Wales is seen to derive more support/opportunity from HS2.
The trading condition – including shortages and rising costs of labour – are important context. Because too many public sector projects are based on cost plans and are not ‘out of date’ and unaffordable. They do not allow for the what the industry is experiencing. Hence why the Bank of England need to know. Projects will slow down as clients review affordability, risk and priority. The impact is that there will be less projects coming to market than planned, procurement will become longer to reach financial close as ‘value engineering or redesign’ will be needed to meet original budgets.
The result could be a race to the bottom. Entirely what we want to avoid and that will impede the whole sector. Some companies will become disproportionally competitive with pricing to secure work and get ‘cash in’ through the door to keep trading even at potentially a loss which will move down the supply chain which is already under pressure through labour and material costs. Does the BofE and HM Government understand this perfect storm? Does Welsh Government?
CEWales has passed the message on. We advocated best practice. Collaboration and integrated team working and early contractor involvement. We even stressed one of the original rethinking construction values: respect for people. If the Chief Economist understands the importance of UK construction, let alone Welsh construction and listened to my message then who knows, we will see a shift in political regard for our sector.