Almost two years ago, I wrote about a looming problem: the potential for contractor default bringing the continuing growth of the London property market to a shuddering halt.
Following Carillion’s recent corporate heart attack, this once rarely discussed issue is certainly being discussed now.
With the construction industry currently running on narrow profit margins, a firm only needs a few contracts to go bad before it ends up in intensive care. In its 2016 CN100 research, trade journal Construction News found that profit margins across the industry’s top 25 contractors were down to 1.2%, compared with 1.8% a year earlier and 2.5% in 2014. This coincides with a feeling from developers that construction costs are substantially higher than previously and well ahead of the projections that many investment decisions are based on.
Although Carillion might be the spectacularly bad apple in the barrel based on recent news, the company is far from alone in an industry in which risk judgement has gone askew since 2008. Contractors behaved too aggressively in their pursuit of contracts, backed by overconfident boards. The ramifications are now becoming painfully clear.
With cladding and insulation on buildings across the UK being tested in the wake of the Grenfell Tower tragedy and litigation undoubtedly set to affect many contractors’ bottom lines, the likelihood of further financial troubles for construction companies is high.
Such exceptional issues aside, why are so many construction jobs unprofitable?
As a sector, construction is not an innovative one. Buildings - houses in particular - are to a large extent built in the same way that they were 100 years ago.
Techniques such as prefabrication and the use of innovative projects are the exception rather than the norm, which means that jobs are costing contractors more than they should.
The sector - seen as traditional and lacking in dynamism - is suffering from a skills shortage and fails to attract new talent.
With Brexit uncertainty reportedly causing an exodus of migrant workers, labour inflation is likely to add to the industry’s problems.
In our experience - with more than 20 developments in our portfolio - contracts are often over-bureaucratic and over-designed.
It should be possible for an experienced contractor to estimate what a 200-unit residential tower should cost without designing it down to the last screw, but a lack of trust and collaboration between developers, contractors and subcontractors leads to projects being a collection of small jobs rather than one team delivering one building.
As a result, jobs end up more expensive and prone to being late, going over budget or failing to reach the requisite quality.
Squeezing tight margins
Contractors are not exclusively to blame.
Clients often fail to bring in contractors early enough; change their minds; might be insufficiently clear on what they want; or - in the residential sector - promise variations to purchasers that complicate the process. Inflexible contracts often mean that extra costs cannot be passed on to developers, leading to further squeezing of already tight margins.
These issues are exacerbated by the use of financially led competitive tendering, which results in too many contracts won on unsustainable margins. It was suggested that pricing pressure led to cut corners on the renovation of Grenfell Tower - an extreme example of the consequences of focusing only on price.
Although it is rare for the race to the bottom to have such devastating ramifications, at the very least, this price-focused behaviour is damaging the construction industry by making increasing numbers of jobs unprofitable.
It is also causing further headaches for developers: delays and overruns are increasingly likely because lowest-price tenders mean contractors cannot afford to resource the delivery adequately.
Carillion is not the only contractor that pursued tenders far too recklessly. It only took three or four botched contracts to almost sink that firm - the result of a culture that rewarded winning contracts at any cost, compounded by a relentless client-side pressure on pricing.
Developers and contractors need to work together against over-bureaucratic and over-designed contracts without letting standards slip. If the industry fails to collaborate with the construction sector, the effects could be disastrous for all of us - not to mention having a devastating impact on our ability to deliver homes to tackle the housing crisis.