Procuring better to sidestep stagnation
Construction may have avoided a recession, but the prospect of an extended spell of weak demand, tight credit conditions and constrained contractor capacity is hardly cause for celebration.
While many in the industry are veterans of the boom-and-bust cycle, the more unfamiliar challenges posed by stagnation should not be underestimated.
And though the growing wave of contractor insolvencies poses significant project risk, clients and their programme managers should use this period of fragile calm to take stock, reflect and implement new ways to tender and manage projects more effectively.
The capacity crawl
While UK construction capacity has been constrained for years by chronic skills shortages, contractors are currently being squeezed by a confluence of three additional pressures:
- A high number of contractors exiting the market through insolvency. Construction is currently seeing a second wave of post-pandemic insolvencies, with 58.1 percent of the casualties being specialist contractors. A total of 4,184 construction firms went bust in England and Wales in the year to the end of March, the highest level since the Financial Crisis. The consultancy EY-Parthenon warned in its Q1 2023 analysis of UK profit warnings that the peak of insolvencies is yet to come.
- With less competition among those who remain, contractors are being more selective and more risk-averse in the types of projects and contracts they bid for, and the tender routes they are willing to accept. This is adding inflationary pressure to tender prices.
- RICS data suggests contractor confidence is weakening. As lenders have increased interest rates and pared back their lending appetite, contractors have become more risk averse in which projects they will accept.
The cumulative effect is to stoke a ‘capacity crawl’ in which declining contractor competition pushes up tender prices despite the weakness of client demand. Reports from Turner & Townsend teams in several UK regions suggest they are already experiencing reduced capacity.
This is largely uncharted, unsettling – and therefore risky – territory. For individual projects, the risk is of cost inflation, delays or even cancellation. For UK construction, the risk is that reduced capacity and flatlining client demand combine to create a sustained period of stagnation.
Just as there are multiple reasons for the industry’s waning capacity, neither is there a single magic bullet to mitigate its impact. Solutions include:
1. Procure proactively and share risk
For all its ease and apparently low risk, the design and build model may deliver neither best value nor optimum efficiency. Clients who take greater control of design may achieve better project outcomes, not to mention a completed asset better suited to their operational needs.
However, moving away from design and build requires a step change, as clients shoulder a degree of responsibility for design, they would previously have passed over to a tier one contractor. While they may need to buy in specialist design expertise, clients will be required to specify much more, more precisely than they are used to – engaging the supply chain early and spelling out the detail of the design before signing any contracts.
Done right, this approach can reduce overall risk and allow risk to be shared more equitably between the client and supply chain, enabling and unlocking greater innovation.
2. Contract competitively but cleverly
Clients seeking a more collaborative, less adversarial dynamic with their supply chain are increasingly using Framework Alliance Contracts to manage their project’s web of relationships, right down to subcontractors.
While this new type of framework agreement requires procurement to be done across multiple contractor tiers, it gives the client greater latitude to incentivise effectively right along the supply chain. Rather than being limited to offering a financial reward to tier one contractors who hit a cost target, clients can incentivise more broadly, for instance by offering a potential profit share to contractors who exceed agreed targets in anything from schedule to carbon use.
In long-term programmes like the Government’s New Hospital Programme, which will see 40 hospitals built from scratch or refurbished in England by 2030, such incentives, together with the prospect of an extended pipeline of work, can encourage tier two and three contractors to invest and innovate in a way no conventional contract model can.
3. Intelligent integration of risk
The emerging role of the Off-site Project Integrator isn’t just shaking up the way risk is apportioned between contractor tiers; it is also driving wider evolution across the supply chain.
The traditional model on large programmes, in which work is broken down into dozens, or even hundreds, of separate packages can allow pockets of elevated risk to form. By contrast, Off-site Project Integrators merge operationally interconnected packages into logical groupings that even out – and reduce – the overall risk profile.
A similar trend of vertical integration is emerging within the supply chain, with several tier-one contractors acquiring MMC manufacturers and making greater use of Platform Design for Manufacture and Assembly (P-DfMA) principles where ‘pop up’ on-site assembly hubs could start to replace ‘traditional construction sites’ and become the norm, where they source and assemble components from a diverse range of suppliers, mitigating supply chain risk.
4. Measure better to perform better
Successful procurement and risk management rely on the ability to understand how a programme is performing right now, while also benchmarking it against – and learning from – multiple previous programmes.
In practical terms, this means investing in digital to provide real-time information and insight, enabling earlier action and driving better ‘as delivered’ and operational performance that is continuously measured against the customer’s desired outcomes.
5. Push for productivity
A raft of new technologies is making UK construction more productive; Office for National Statistics (ONS) data shows output per hour worked grew by 5.2 percent between Q1 2022 and Q1 2023, the fastest improvement of any sector of the economy.
Clients who adopt a ‘digital-first’ approach – in which digital tools and AI software enable complex but repetitive tasks to be completed quickly and efficiently – can boost productivity right from the project’s inception, delivering ‘right first time’ outcomes through design, manufacture and assembly.
During the construction phase, 3D mapping drones and autonomous robots capable of performing strenuous tasks like excavating, bricklaying and pouring concrete are reducing the amount of human work required on-site, thus increasing both productivity and safety. In addition, pre-fabricated composite items ranging from bridges to facades significantly reduce labour, waste and schedule, while all-electric site vehicles are being trialled to reduce carbon and emissions.
Do’s and don’ts of procuring to ease the impact of a capacity crunch
Do
- Warm up, engage and listen to the market ahead of the formal pre-qualification process.
- Confirm the availability of key personnel. Procurers should carry out greater due diligence of the past performance of all bidders and their current exposure to challenging projects.
- Evaluate the current financial status of contractors and suppliers by reviewing parent company guarantees or performance bonds.
- Identify skills gaps early and invest in recruitment, learning and development.
- Assess project success in terms of value rather than just price.
Don't
- Focus on cost over quality. Look beyond low upfront cost to unlock best value – including whole-life cost and whole-life carbon.
- Load up on unnecessary risk clauses. These may pass more risk and liability down a fragile supply chain.
- Neglect project controls. Harness real-time data on both progress and defects to limit the impact of a contractor entering insolvency during a project.
- Hesitate. If a contractor does become insolvent, clients must engage their legal advisors swiftly to review contracts and ensure they are fully agreed, with no dispute over terms.
- Overlook the programme. Challenge assumptions on time and drive out scheduling and sequencing inefficiencies to accelerate programme delivery.
© 2023 Turner & Townsend