Given all the challenges and setbacks a developer must survive before the first shovel goes into the ground on a new project, it must feel like a particularly brutal punch in the face when a contractor suddenly collapses before completing the work.
The shock may be tinged with sympathy for the fate of the builder, but it is bound to hurt. There will be fewer risks ranked higher on the development plan in terms of impact, save perhaps running out of money to pay the contractor in the first place.
This week we ponder some of the ways forward for firms that find themselves in this predicament.
Last year was a bad one for insolvencies in the construction sector, and it’s unlikely that 2024 will post much of an improvement. Downturns and economic shocks are generally bad for all businesses, but construction firms tend to be particularly poorly insulated due to the very thin margins seen across the industry.
According to our sister publication Construction News, contractors with a turnover between £200m and £400m made a median pre-tax profit margin of just 2.3% in their latest full-year results, while the biggest builders, with £1bn-plus turnover, achieved a median margin of just 1.9%.
Among subcontractors studied by CN, the most recent median margin was a similarly meagre 3%.
Construction firms tend to be poorly insulated due to their very thin margins
In short, profit margins even on a good day tend to be low enough to make the casual observer assume the decimal point must be in the wrong place.
Another familiar pattern in the construction sector is the tug of war between different parts of the supply chain. In years when main contractors’ margins rise, for example, it’s not unusual to see subcontractors’ profits fall, and vice-versa. Each side naturally tends to exploit its bargaining power as the volume of work rises and falls.
Conversely, times of broad economic distress typically push both parties down together, increasing the number that run out of cash. Desperate firms can be pushed into bidding for contracts at below cost, hoping to claw back profits later by billing for variations, a tactic that doesn’t always wash.
The result is dead firms walking – zombies that may not realise their game is over. To make matters worse for such firms, it’s the market upturn that often proves finally fatal. As confidence returns, competition for scarce commodities – such as skilled workers – inevitably rises. In turn, that means the cost of delivering on low-balled contracts can start to balloon. Contractors and subcontractors can easily find themselves very busy losing money.
For the developers currently reliant on contractors to deliver projects, none of these trends will be comforting. Changing horses midstream is never easy, even if you try to foresee the risk and build horse-swapping caveats into a contract.
The wiser course outlined in our feature is to do the opposite; to aim to forge stronger relationships with trusted partners, and to discuss financial difficulties more openly.
And who knows, budgeting to give the builders a bigger cut might not be such a bad investment.
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