What’s the real answer to construction’s apparent inability to pay its suppliers? More investment, driven by greater innovation
Two recent headlines highlighted for me the financial gulf between traditional construction and emerging sectors such as offsite. On the one hand, new kid on the block Top Hat announced a £75m investment courtesy of Goldman Sachs, and on the other, leading UK contractors such as Balfour Beatty, Costain and Laing O’Rourke were kicked off the Prompt Payment Code for failing to meet its standards. The contrast provides some telling insights into how the industry is financed and rewards shared.
To put the Goldman Sachs investment into context, Top Hat secured almost as much money as the government has provided for the Construction Innovation Hub via the sector deal. It is a huge achievement for a construction start-up to have won an investment partner with such deep pockets. However, Goldman Sachs will no doubt expect an attractive return on its investment.
It doesn’t feel right to me for the industry to rely on clients to put in specific measures to ensure suppliers get paid. Besides, project bank accounts are just a sticking plaster on a bigger problem
In any case, is the investment really aimed at construction? After all, Top Hat is a housebuilder as well as an offsite specialist. Is the investment aimed at land or manufacturing capacity? If in the end the target is land acquisition, then Goldman Sachs’ investment will highlight how difficult it is for even innovative construction businesses to attract investment.
The relationship between conventional contractors and their investors is much less cosy. How could it not be, given that margins on turnover are so low? Last year, only 38% of Kier’s £264m rights issue was taken up by shareholders. If the UK’s second-largest contractor is struggling to secure support from investors, what prospects does the wider industry have?
This brings us to the payment issue, a problem that has characterised the industry for so long we have become habituated to it. Free cash is one of the most important measures of business performance, and the slow movement of cash through the supply chain not only increases requirements for working capital but also can lessen the attraction of a business to investors. Poor payment practice makes firms not only less profitable but also less investable too.
There have been positive developments. The payment performance of all companies with more than 250 employees is now regularly monitored by government, and Build UK has set a great example by publishing data on its members’ payment statistics. The benchmarks have had some effect, as some Build UK members have improved their performance since data publication started. But it appears self-policing is not a big enough stick. To have some of the UK’s largest construction companies struck off the Prompt Payment Code is deeply disappointing. This must be seen as a call to action rather than another regrettable chapter in our industry’s business relations.
So, who needs to take the action? Cash flow management clearly has an important role in main contractor finances, so it could be argued the responsibility should sit with tier-one contractors to price and manage projects on a basis that enables suppliers to be paid in line with contract terms. By contrast, specialist contractors have made the case for some time that clients should set up client bank accounts to increase assurance around payment.
It doesn’t feel right to me for the industry to rely on clients to put in specific measures to ensure suppliers get paid. Besides, project bank accounts are just a sticking plaster on a bigger problem. They don’t protect the interests of suppliers and subcontractors below the second tier, but more importantly they would continue to disguise the sector’s disappointing business performance – of which slow payment is a symptom, not a cause.
An industry able to pay itself promptly is one that can secure work at profitable prices by delivering excellent value to clients. But the current business model undermines profitability through lowest-price bidding, inappropriate risk transfer and waste. A big step to getting payment right involves improving procurement – ideally on the collaborative, enterprise basis set out by Project 13, but more likely on lines that enable firms to make a reasonable return. Procurement reform is, however, a double-edged sword. Few clients will proceed with a project unless they are confident of paying a fair price and obtaining a good outcome. Any shift in the balance of commercial pressure and risk transfer will need to be offset by the supply chain providing greater certainty and better value through improved productivity and greater transparency.
Perhaps this is the point that brings together the two aspects of money I’m discussing – investment and payment. Investment in innovation, as supported by the construction sector deal and the Construction Innovation Hub, can make organisations more productive and more valuable, creating the potential for competitive advantage and improved performance. Firms that are able to invest in these improvements should deliver better outcomes to clients. They are also more likely to be the better payers – and thus able to attract and retain the best suppliers.
One way or another, the industry has to sort out the payment challenge. It’s an issue that can’t be separated from the wider reform agenda. Through improvement procurement practice, everyone involved – clients, consultants and contractors – has a role in making sure people get paid on time. It may not be as exciting as funding from a Wall Street bank, but it will go a long way to making the industry more investable.
Simon Rawlinson is head of strategic research and insight at Arcadis and member of the Construction Leadership Council