03/11/2010

Getting the construction industry back on its feet

The coalition Government has pinned its colours to the mast of private sector growth and the years of plenty are over. High levels of public sector spending on infrastructure projects which we saw under New Labour have now succumbed to a period of austerity. This is forcing a re-think amongst contractors large and small as to how to re-shape and re-size their businesses.

A prime example of the cuts lies in the Building Schools for the Future (BSF) programme. Tens of billions of pounds were committed to this initiative and a great number of construction professionals and contractors resourced their businesses accordingly.

The BSF programme has been put on hold and it is unclear when it will be reinstated, albeit in a leaner shape. What is clear is that those businesses which hired large teams of specialist workers to design and construct the hundreds of new and refurbished schools up and down the country will need to react quickly. If those resources are under-utilised then it is likely to have a negative impact on profitability.

Ordinarily a contractor would seek to replace a downturn in one type of work by redeploying a skilled workforce on an alternative but similar area of work, where many of the same specialist skills and experiences can be translated with relative ease. The difficulty with this in the current economic situation is that public procurement across all areas is being reduced savagely.

During the recession of 2008 to 2009 private sector development and procurement all but vanished as funding dried up. But at least there was still public sector procurement to fall back on, and this acted as a crutch for many contractors and design professionals.

The sharp and painful reality of a slump in both private and public sector procurement is now biting. It is hard for resources to be deployed in other areas of business when there just is not much business at all.

The reality is that construction businesses need to move quickly, if they have not done so already, to ensure that they have the right level of resource to operate in these austere times. Businesses which carry excessive numbers of staff will inevitably lose their competitive edge.

Either they will price for work at too high a rate in order to cover their costs or else if they try to compete on price they may simply fail to generate sufficient profit. Reducing the workforce is not straightforward, and can be hugely damaging to morale within the business.

It needs to be carried out in a well managed systematic manner and in accordance with all relevant employment laws. Proper legal advice should be taken in order to minimise the disruptive effects on the business of any redundancy programme and to avoid the financial penalties of unfair dismissal claims.

Of course there are other ways in which construction businesses can seek to withstand the current economic challenges. Many contractors have already recognised that as new build procurement declines, so this can increase the amount of maintenance and refurbishment work which replaces it.

Occupiers or users of ageing properties and infrastructure who cannot afford to replace it must therefore maintain what exists. Some contractors have already very successfully re-assigned parts of their business towards this type of business offering.

It is anticipated that over the next five years the amount of planned and reactive maintenance and refurbishment will increase dramatically, especially in the public sector where investment in new capital projects will be stifled.

It remains vital for businesses to ensure that they protect or even enhance profits from existing contract work. This is, of course, what every business would say that it was trying to do in any event. However in the construction industry it is easier said than done.

Unlike other areas of commerce, where transactions can last only minutes, hours or days, most commercial construction projects last months or years. Consequently the potential for things to go wrong or for irrecoverable overspend is considerable. This usually has a disastrous impact on the profit margins on a project as well as on the relationship with a customer.

The most successful businesses appear to be those who are able to manage the almost inevitable range of things that go wrong during the course of a project in such a way that they get back on track, minimise additional expense and retain the valuable client relationship.

Even if a dispute arises between a contractor and its employer this can and should be project managed just like any other business project. In other words there should be a clearly specified commercial objective, a programme for its delivery, and a cost plan. Invariably this leads to a faster, better solution.

Much of our work at Gordons over the last two years has involved working closely with contractors and employers to help them to manage problems which have threatened to overwhelm the business in terms of cost, effect on profitability and drain on management time.

Our management tool called Initial Strategic Review (ISR) has helped numerous businesses to analyse problems at a very early stage, identify the best commercially achievable solution and then to implement a strategic path and programme to realise this before it is allowed to impact negatively on the business.

For the construction industry this appears to be a useful project management approach, enabling early identification of risk to profitability. By treating the threats to the business in a strategic way and managing them in a structured way just like any other business project, this appears to be something which can make a major difference to the profitability and stability of a business.

As we move slowly out of the recession there is evidence businesses make further funds available to pursue litigation against debtors. We saw this in the downturn in the early 1990s and again in 2001 when there was an economic dip. In the depths of the downturn many companies cannot even afford to pursue claims even if they have merit.

But as cash flow becomes less under pressure then it becomes viable to pursue them. Hence we typically see an increase in the litigious behaviour of contractors as we move out of recession. Behind this is the fact that most commercial construction contracts have either a six or twelve year period in which to bring any claims to court. Contractors can afford to sit and wait to pursue claims many months or sometimes years later.

We are already seeing a repeat of this pattern in 2010 and it looks set to continue throughout 2011 as businesses scramble to shore up their finances and recover as much cash as possible. Whilst the notion of an upturn in litigation within an industry which has never been shy of disputes might not immediately be an appealing thought, there may be a positive angle.

In each of the preceding downturns the increase in litigation has fairly shortly been followed by a return to normality and a steady increase in the growth of businesses who survived the recession. There is every reason to hope that history will repeat itself again.

If you wish to discuss the issues raised in this article, or any issues around construction procurement, please contact Richard Piper, head of construction at Gordons on 0113 227 0100 or email richard.piper@gordonsllp.com.