The double-dip recession that the industry has been dreading is finally upon us. But exactly how bad are things out there, and how much worse are they going to get? In the first part of Building’s State of Play series examining the health of the industry, sector by sector, Emily Wright gives the prognosis for contractors
The construction industry has spent the last four years rolling with the punches. Recession, redundancies, cuts and the evaporation of investment have all become facts of life. Now, after a period of relative grace, the blows are raining down harder than ever. Last month’s Office for National Statistics (ONS) GDP figures revealed a 3% contraction in construction output between January and March, a fall that some have suggested was responsible for pushing the UK economy as a whole back into recession.
And this is just the start of the real pain for many contractors - especially larger firms - according to Rick Willmott, group chief executive of Willmott Dixon. “The recession we have been predicting since 2010 has finally arrived,” he says. “Up until this year, many contractors’ results benefited from good work volumes procured in the last few years. This year and going into the next, falling work volumes combined with acute margin pressures will see the industry face the hardest phase of the downturn. Work procured now will define performance over the next two to three years and contractors that chase work at all costs will expose themselves to serious risk.”
This is already being reflected by a volatile atmosphere that is spreading across the contracting sector. Within the last month alone there has been news of a major restructure at Balfour Beatty’s construction division, contractor Killby & Gayford has gone into administration and medium-sized firm Thomas Vale has been subsumed by French giant Bouygues.
Things may look bleak at the moment but there is some hope for contractors. Stephen Ratcliffe, director of the UK Contractors Group (UKCG), points out there is £90bn of public sector work out there to be won.
There are also glimmers of hope in other sectors - some of which might even favour smaller firms. Here we consider the common challenges facing UK contractors, examine how key sectors are faring and gauge where new opportunities may lie.
Three of the main challenges facing the contracting sector:
Rising materials prices
So far, materials price rises have averaged 0.9% in 2012 but have been more widespread than in previous quarters. According to Experian’s latest report, “manufacturers who held off raising prices last year have felt unable to hold them for a second year running”.
Aggregates, concrete and cement prices have all risen by about 4% in the last year and bricks have risen by as much as 12%. Rising oil and gas prices are likely to have a serious impact on materials, as energy-intensive manufacturing processes such as cement and brickmaking force suppliers to pay more.
With contractors competing for limited work, rising materials prices are making it increasingly difficult for firms to put in competitive tenders, regardless of their size.
As Willmott points out, this means that contractors who have already put in unrealistically low bids to win work will find themselves in an extremely difficult situation as their margins are squeezed even further.
An escalating regional crisis
UKCG’s Ratcliffe says that 60% of public sector work occurs in London and the South-east, an imbalance that is causing problems for regional contractors.
The introduction of the High Speed 2 rail link is likely to improve things but, with such a long run-in time, is by no means an immediate fix.
Construction outside London is a vital issue not just for the industry but for local communities, Ratcliffe points out. “For every £1 that is spent on construction, 94p stays in the UK,” he says.
“Construction is good for growth. We are approaching local authorities and campaigning for areas like Yorkshire and Humberside to invest in infrastructure as a matter of urgency. It is this sort of thing that will have a huge positive economic impact.”
Spending cuts and competition
Cuts to public sector spending have been looming over the industry for the past 18 months and have now finally hit home, with devastating effects. Orders for non-domestic public buildings, such as school, hospitals and prisons, were down 35% in 2011 compared with 2010.
Going for the big schemes is alright until you hit a recession. Then you are on a learning curve to try and pick up other, smaller-sized jobs
John Crawley, Skanska
As a result, competition for jobs is at fever pitch. Great Portland Estates’ head of projects James Pellatt says: “I wonder whether some of the bigger contractors will give up on bidding for the jobs they have traditionally gone for.”
A knock-on effect of this has been a trend for larger firms to move into SMEs’ territory and bidding for smaller jobs they wouldn’t have touched in boom times. Lend Lease kicked off a strategy to focus on smaller jobs last year, as did ISG, McAlpine and Skanska.
John Crawley, Skanska’s London operations director, says: “Going for the big schemes is OK until you hit a recession. Then you are on a learning curve to try and pick up other smaller-sized jobs.”
Big worries: The state of play for major contractors
Large contractors have often been considered the construction industry’s ocean liners - better able to glide through rough seas, but with the disadvantage of not being as quick to steer a new course as their smaller counterparts. This lack of nimbleness could prove damaging in a fast-changing market, as many of the large projects that have been sustaining these firms come to an end.
Restructures are likely to become more commonplace, according to construction commentator Brian Green, following the announcement last month that Balfour Beatty, the UK’s largest contractor, was putting all 12,000 staff across its construction arm on notice as part of a shake-up to “position for growth”.
With a much heavier reliance on public sector work than smaller firms, major contractors have been left reeling as we head into the second half of 2012.
Pellatt says that larger firms may even move away from traditional contracting altogether, opting instead to bid for infrastructure and nuclear schemes: “I think we will see a lot of hardship among the large contractors. Some of them may even disappear, and I am talking about some really
“They can’t afford to keep bidding for big jobs and losing due to increased competition and lower bids.”
Reasons to be fearful
- Increasingly fierce competition for large jobs due to low bids
- Government spending cuts hit the larger firms hard due to them having a larger proportion of public sector work than smaller firms. Plus, there is still uncertainty hanging over the nuclear pipeline
- Major projects that have been sustaining the industry from 2008/09 are coming to an end.
Reasons to be cheerful
- Infrastructure schemes including HS2 and billions of pounds of energy, utilities, road and rail projects, all backed by the government
- There are still potential overseas opportunities in growth areas including eastern Europe and Asia
- There may be specific chances to cash in on London 2012 by exporting sports-related construction expertise to countries such as Brazil - host of the 2014 FIFA World Cup and 2016 Olympics - and Qatar - host of the 2022 World Cup.
Small hope: The state of play for SMEs
Small contractors are more likely to be further down the supply chain than their larger competitors, and this can put them at a disadvantage. With banks not lending, materials prices soaring and margins being squeezed, smaller contractors without much financial stability are feeling the pain in 2012, a situation made worse by increasing competition for work as main contractors cast their nets wider.
“Times remain tough for SMEs, with payment issues still causing huge problems and the overarching outlook remains pretty depressing,” says Suzannah Nichol, chief executive of the National Specialist Contractors Council. “Plus, the number of apprentices being employed is down and we will have a huge problem with a skills gap if we’re not careful. People don’t see it now, but from 2014 onwards the supply chain will be absolutely decimated if we do not look after the skills we have.”
News of medium-sized firms being bought by large contractors, such as Bouygues’ takeover of Thomas Vale, might be a sign of things to come if SMEs want to a) survive and, b)prosper in a shifting market.
Reasons to be fearful
- Where to begin? Financial insecurity and late payment continue to dog the lower end of the supply chain
- There are skills shortages, which are going to become more acute from 2014
- More intense competition for work as the larger firms move in on smaller projects that have traditionally been the realm of SMEs.
Reasons to be cheerful
- An increasing preference among developers including Great Portland Estates and Development Securities to work with smaller, more loyal, firms rather than the larger contractors
- With many 25-year commercial leases coming to an end and a lack of new build space, there will be an increased need to update existing stock.
Sectorwatch: Where the opportunities are
Ratcliffe describes this as “the biggie” and last month’s Construction Products Association (CPA) forecast figures identify infrastructure as one of the only growth areas in the sector. The £250bn National Infrastructure Plan (NIP) gave government backing to 40 major schemes between now and 2016 and CPA figures show that infrastructure output growth is expected to be 6% year on year until 2016, when it will be worth £17.3bn.
Rail overtook roads as the biggest growth area in infrastructure in 2011, with output totalling £3.3bn and new orders doubling. Roads output, by contrast, contracted by 46% but is still worth £3.2bn, or 24% of total infrastructure construction. One billion pounds will be invested in improving the national road network in 2012/13. Water and sewage has a planned £21bn framework spend between 2009 and 2015 and was worth £2.1bn in 2011. The sector is expected to grow, on average, by 7% year on year through to 2015. Output in electricity network upgrades is set to triple by the end of 2016. This is being driven by year-on-year rises in nuclear and renewable work of 18% in 2012, 20% in 2013 and 30% in 2014.
Capital spending on health premises in the UK was £5.1bn in 2010/11. This figure is expected to fall to around £4.4bn a year until 2015. Output in the sector fell by 17% in 2011 and orders fell a huge 47%. Much of the uncertainty around primary and secondary healthcare premises and the resulting lack of a clear pipeline, stem from the continuing confusion over NHS reform. But there is still likely to be work on hospital upgrades, refurbishments and extensions, as well as the creation of new, larger GP surgeries, as 23% of the NHS estate remains “unfit for purpose”, according to AMA Research.
CPA figures show that output for the education sector fell by just 2% in 2011 and remained at £7bn. The future, though, looks less clear. As projects finish, they are unlikely to be replaced at the same rate and output is expected to fall sharply by 20% in 2012, 14% in 2013 and 6% in 2014.
However, tenders are expected in the autumn for the government’s £2bn Priority School Building Programme, which should go some way to boosting the sector.
With big-name clients including Development Securities and Hammerson diversifying away from the commercial sector, the future doesn’t look bright. Office projects’ share of commercial output fell to a historic low of 26% in 2010 and saw only a modest 3% growth on this last year, while orders fell by 5% to £3.6bn.
With major London commercial schemes such as the Pinnacle being put on hold due to lack of finance, and with many clients opting to convert commercial space into residential units instead, it will be a while before there is any light on the horizon.
Retail is faring a little better, according to the CPA forecast, growing 5% in 2011 to reach a sector value of £5.4bn, which equates to 22% of overall commercial output. Fuelled by supermarkets’ aggressive expansion plans, this sector is a good place to be for contractors of all sizes thanks to the wide range of projects, from superstores to convenience chains.
However, retail clients are notorious for preferring to work with an established supply chain, so if a contractor does not already have a relationship with them, breaking into this sector may prove tricky.
What clients want
We asked three top clients what contractors can do to stand out in such a competitive market:
The retail client: Tony Jacob, head of construction, engineering and environment at John Lewis Partnership
“We always ask that our contractors try to think like retailers, especially now that the sector is facing its biggest-ever challenge in the current tough economic climate. Our supply chain needs to offer us ever more reliable services at a reduced cost. It must be able to design space that is more flexible than ever and adapt to change along the delivery journey in a controlled way.
“Everyone in the retail industry, including John Lewis, must prune their capital and revenue budgets. Saving money on utilities and maintenance costs is increasingly vital to our ongoing profitability. So our suppliers need to be both efficient and honest enough to be able to tell us where we’re getting it wrong.”
The private sector client: Julian Barwick, head of development at Development Securities
“As a developer, we are moving away from commercial work into residential and retail so we’re looking for a shift in skills. This could open the door for new firms but, equally, we are seeing our existing supply chain adapt too, as the market has ebbed and flowed. So many of them have now developed skills in retail and residential. We’re looking for a good track record, innovation and willingness to challenge.
“The best suppliers, without overdoing it or taking it to an excess, are those that find themselves treading on the toes of the other members of the design team. There is nothing I like better than seeing structural engineers persuading the architects to move in a certain direction, for example.”
The major public sector client: Dennis Hone, chief executive of the Olympic Delivery Authority (ODA)
“The ODA has strived from the outset to get contractors to buy into challenging targets and their response has been nothing short of fantastic.
“The proof? We have built the stage for the London 2012 Games on time, within budget and having achieved new benchmarks across a range of areas.
“These include tough sustainability targets, industry-leading health and safety records, and emphasis on local workforce and apprenticeship employment. That’s what we asked from our supply chain and that’s exactly what they delivered for us.
“The record of the British construction industry is as good now as it has been in an extremely long time. I believe that the London 2012 project has really helped to promote the UK’s expertise to a global audience.”
Views from the Top
Three construction bosses predict what the future might hold for UK contractors
John Stanion, CEO, Vinci Construction UK
“I expect demand to continue to decline in the building market for the next two to three years as cuts in public spending feed through into reduced demand in health and education and more generally. Private sector building demand is unlikely to expand to fill the gap and with the banking sector shrinking balance sheets, increasing capital ratios and becoming more risk averse, I expect this to act as a drag on recovery.
“Civil engineering should be more positive, but the key here is to create investment conditions that will encourage the private sector to support the objectives set out in the NIP. The level of competition is unlikely to ease and margins will remain under pressure for the period ahead. The industry remains, however, a potential engine for economic and employment growth if aspirations in the NIP can be met.”
Andrew McNaughton, chief operating officer, Balfour Beatty
“Given global demands, we see good opportunities for infrastructure lifecycle companies like ours both in the UK and abroad. The UK government is a firm believer in the virtues of, and the need for, infrastructure investment and we are excited by the opportunities in growth sectors such as rail and power and growth markets like Australia, Canada and India.
“We see good opportunities in the medium term for integrated infrastructure companies like ours. As opportunities arise, we are determined to be ever more efficient and competitive.”
Paul Sheffield, CEO, Kier
“The GDP figures were interesting - although the ONS needs to get to the bottom of the huge variability in the monthly figures, I don’t think they really represent what has been going on over the last six months in any detail. Housebuilding and infrastructure are reasonably buoyant, yet the traditional building sector is still very flat and there are few signs of growth. The ongoing review of PFI inevitably means that new schemes hitting the ground are still a few years away.
“However, those businesses that have the spread of capability to excel in the heavy infrastructure market do have significant opportunities ahead. So too is there a lot of scope in the many mixed-use re-generation schemes across the country for those who can masterplan and create their own opportunities through property development - that is a real focus for us at the moment.”
We knew it was coming…
Simon Rawlinson, head of strategic research at EC Harris considers how contractors are placed to rise up from the double-dip
“The UK’s re-entry into recession may have come as a surprise to many commentators. But construction has known that its double-dip has been coming for some time - providing contractors with an incentive to lock in to frameworks or to diversify into sectors that have been forecast to remain more buoyant.
“Markets are exceptionally challenging, but main contractors have the strategic opportunity to develop propositions that add greater value to their clients - through earlier involvement in integrated teams, for example, or by using Building Information Modelling to de-risk delivery. Contractors that evolve their business model will be in a potentially strong position when the recession ends.
“Work-winning tactics in the short term are absolutely critical. Four years into the construction downturn and despite increased output in 2010 and 2011, many contractors have run down their cash surpluses. They are also potentially exposed to losses on projects secured through highly aggressive pricing. Avoiding future liabilities is critical. With workload still scarce, and clients still being able to call the shots in terms of their choice of procurement route, bidding for projects is highly competitive. Given the extent of risk transfer required by many clients, contractors are becoming risk averse themselves, both with regards to their own contractual terms and the agreement of subcontractor costs.
Recent developments in the market have, if anything, increased levels of uncertainty. Reorganisations in big-spending government departments such as the Ministry of Defence and the introduction of complex new frameworks, including the Priority Schools Building Programme, have led to delays in the procurement of major public sector projects.
At the same time, the commercial sector has been hit by the stalling of many office schemes due to funding constraints and, more recently, a reduction in retail roll-
The upshot of these developments is that the market is unlikely to start to recover until towards the end of 2012 in London and 2013 in the regions. Given current conditions, main contractor failures, such as the recent insolvency of Killby & Gayford, can’t be ruled out. However, the latest data from insolvency specialist Begbies Traynor suggests that although around 1,200 construction firms are rated as “critical”, the overall condition of the sector has not deteriorated further this year - a small comfort for the rest of the sector.
There are a few bright spots for contractors, but most involve frameworks and long-term relationships. From a workload point of view, the obvious sector to be in is infrastructure. However, barriers to entry are high in some instances and many infrastructure clients are facing their own performance and cost reduction challenges.
Local authorities are also an area of innovation and opportunity, with Manchester’s £1.2bn City Deal being one of the more positive announcements in the last budget.
With greater local autonomy and cooperation between public and private bodies, Regional Improvement and Efficiency Partnerships (RIEPs) have the potential to be a significant route to the market, and Next Generation frameworks for SMEs and major contractors are now in place.
Mega projects - in the commercial, energy and transport sectors - are still out there, but provide opportunities for only the largest contractors with the capability to deliver. And these will no doubt become even more competitive as all firms seek to secure vital long-term work.
NEXT WEEK, READ ABOUT THE STATE OF PLAY FOR CONSULTANTS
Building’s Specialists White Paper reveals the impact of recession on the UK’s specialist contractors, enabling clients and main contractors to identify strengths and weaknesses in their supply chains. It also provides:
- Analysis of the outlook for specialists by sector
- Interviews with key contractors and clients, including Balfour Beatty and Skanska
- Insight into the impact of government policies aimed at helping specialists and SMEs
Click here to purchase the Specialists White Paper