Firms can deliver more value and become less vulnerable by following these steps to improve allocation between clients and contractors
A fuller picture emerges of the true value that construction delivers for the economy – and its potential to deliver more – in two recent reports from the CIOB and the CBI. There is no shortage of attempts to detail what is wrong with the sector but the CBI provides a helpful analysis of what is at the nub of the construction conundrum in Fine Margins: Delivering Financial Sustainability in UK Construction. In short, it’s about risk management.
As the report says: “Poor risk allocation between clients and contractors prevents construction projects from being procured and delivered successfully, and the prevailing industry structure leaves major contractors and their subcontractors especially vulnerable.”
More importantly, it has valuable ideas for improving our risk management. I cannot possibly summarise them all here, but here are some key steps worth highlighting:
Get away from the turnover trap
One need look no further than the collapse of Carillion to see what damage a fixation on turnover growth brings. Yet we are still stuck in patterns that evaluate companies based on turnover, whether in trade press league tables or clients using minimum turnover thresholds as prerequisites for contracts.
We have got to shift the focus onto sustainable profitability and promote measures that truly demonstrate economic strength, such as profitability, operating cash flow and net cash/debt. The government should heed the CBI’s recommendation to task either the Construction Leadership Council or the CBI with monitoring the relationship between margin and revenue.
Focus on value, not cost
Contractors and clients need to recognise the damage of awarding contracts on the basis of lowest cost. When these bids arrive at unrealistic levels, businesses “should be prepared to challenge or walk away”.
I hope clients and consultants give this due consideration – that the lifetime value of property assets should guide decisions, not the lowest construction cost. As a colleague on the CBI Construction Council is known to say: “You wouldn’t choose a heart surgeon based on lowest cost.”
Collaborate from the start
We know that the lack of collaborative mindset is part of the sector’s problems. We are not managing risk well because of some entrenched, antagonistic behaviours, and these start at the procurement stage.
Six frequently-used contract terms that should be avoided, including uncapped liability
The CBI report highlights that further development of the government’s outsourcing playbook, and in particular the removal of uncapped liability clauses from contracts, is essential to a fair management of risk.
These are within our power to fix, and we are already making progress. Clients should pay particular heed to the Build UK contract terms recommendation, which suggests six frequently-used contract terms that should be avoided, including uncapped liability. These terms are often inserted in the misguided belief that they will help to manage risk. Instead, they create unfulfillable expectations and push risk down into the supply chain in a way that is inequitable.
Follow the roadmap towards no retentions
The mix of high-risk projects and slim margins results in practices that are not ideal, such as retentions. The report recommends: “Public sector procurement guidance should prohibit the practice of holding retentions on public contracts by clients or by suppliers.”
The shared objective of zero retentions
It notes that CBI construction council members reflect a net negative position – that is, they are owed more by their clients than they owe to their supply chain. CBI members estimated that the values owed to them amounted to between 1.8% and 4.5% of annual turnover.
The Build UK retentions roadmap shows how the whole sector can move together, in a way that minimises risk, towards the shared objective of zero retentions.
The value we generate
Based on analysis by Oxford Economics, the CBI reveals that for every £1 invested in construction, we deliver nearly £3 in value. Construction activity contributed £116bn to the economy in 2018, or 6% of gross value added (GVA).
We should be proud of that, but it could be so much more if we get risk management right. The Oxford Economics analysis showed that an increase of 2% in productivity has the potential to deliver £30bn more in output every year.
The contribution to the UK economy would be closer to 10%
The CIOB report, The Real Face of Construction 2020: a Socio-economic Analysis of the True Value of the Built Environment, complements the CBI report by giving us statistics to demonstrate why construction is so important. We know that we have a more profound impact than we are often given credit for. The CIOB suggests that if we were to define construction nearer to how the industry sees it, the contribution to the UK economy would be closer to 10%, possibly more, with an annual gross value added of about £200bn.
And this does not even capture the fact that quality infrastructure, housing and work environments make for more efficient businesses, healthier people and more productive learning environments.
We are an ecosystem of architects, engineers, quantity surveyors, contractors, specialists, facility managers, investors and many others – all working together to create spaces, infrastructure and buildings that improve people’s lives and make the economy work better. We are economic multipliers. What we do is important and valuable – just as these reports articulate.
James Wates is chairman of Wates Group, the BRE Trust, and the CBI Construction Council