Contractors are in a Catch-22 situation – they need to invest to modernise – but must modernise to invest
Main contractors are in a Catch-22. Many of the big names are struggling to survive on pitiful margins, the number of contractor profit warnings have reached a new high, while investor confidence is at an all-time low.
On top of all that they are under huge pressure to improve their supply chains’ payment terms, which – though clearly the right thing to do – threatens to suck even more cash out of their businesses.
And what is the expert advice for getting out of this fix? You have to fundamentally reshape your business by focusing on new digital and offsite technologies.
And here’s the catch: we all know that abandoning traditional models and practices requires investment, which requires cash, which is exactly what contractors are short of right now.
Abandoning traditional models and practices requires investment, which requires cash, which is exactly what contractors are short of
This was the very urgent topic up for discussion at last week’s Building Live Club, entitled Digital Futures and Managing Risk.
The panel discussions at this event perfectly summed up the dilemma facing many companies right now – they need to make a great digital leap forward but they appear trapped in a cycle of outdated practices.
Repeatedly our panellists from all industry backgrounds – consultants, developers and contractors – told us that the current construction model was “broken”.
You could hear the frustration in their voices when the likes of Robert Rotbart from Derwent London described “archaic ways of building” and Stephen Beechey at Wates talked of “old-fashioned behaviours”.
Beechey was particularly scathing about contractors undercutting each other in a desperate attempt to win work, which in his view is perpetuating low margins: “We are already seeing signs of cut-throat pricing and we haven’t actually got into recession yet.”
So, are contractors their own worst enemies? Perhaps, but the panel clearly felt clients play their part in driving down prices, and that consultants can play a crucial role in educating them that cheapest rarely means best value.
In the early noughties, some businesses tried to circumvent low margins by blending FM and support services work with more traditional contracting – Interserve, Kier and Carillion all spring to mind.
And for a while City investors welcomed the move. How times have changed. The lesson seems to have been that while you can make better margins, support services and contracting don’t mix well within the same business because the cashflows run counter to each other.
Put simply, contracting brings in cash upfront, while support services takes it out at this stage, and you need a management team with very different skillsets to run both at the same time.
Contractors now risk being smothered under their debt piles
Clearly FM and support services were not the silver bullet some had hoped, but worse is that contractors now risk being smothered under their debt piles.
Since the collapse of Carillion, City investors take a very dim view of indebtedness and during the Building Live Club, Ian Marson, Ernst & Young’s UK head of construction, really made people sit up and listen when he warned those with high levels of debt who will need to refinance in the next couple of years simply won’t be able to.
He said funders are withdrawing from the sector because the low margins mean they don’t see the sector as a place they are going to get a return for investors.
These businesses need to act urgently to address their debt levels and to change their models before they have to refinance. Marson’s advice to contractors was to focus on improving their portfolio of contracts.
This means not just making statements about not bidding for low margin work, but actually making sure all parts of their businesses refrain from doing it.
Of course, there are contractors out there that have subscribed to this view for some time, and speaking to one, he was quite relaxed about having access to finance, having been reassured by lenders that when the time comes refinancing will not be a problem.
If you are one of the contractors that has already moved to de-risk your business, you can probably be relatively optimistic about the future, albeit a no-deal Brexit appears more probable by the day and carries with it innumerable unknowns for the wider economy.
In simple terms if, over recent years, you have worked to drive up margins on contracts, to only take on jobs where the risk is understood and the reward appropriate and to invest back into the business to take advantage of new technology, then you are already ahead of the game and investors will be interested.
By contrast, if you are taking on onerous contracts, not managing your cash, still using traditional models and techniques and relying on ultra-low debt, you’ll be in for a shock when it comes to refinancing and probably will not be in the game at all.
And what about the industry as a whole and its Catch-22 of needing to invest to modernise but having to modernise in order to invest?
Well, Marson at EY pointed out that already we are seeing disruptors – companies from non-construction backgrounds investing in modular technology, for example – and cherry-picking work in high-margin markets.
The message is clear: if contractors cannot find a way to break the deadlock, others will.
Chloë McCulloch, editor, Building