Tender prices continue to be driven up by labour costs, although prices are not seeing the steep increases of the previous two quarters. Margins throughout the supply chain have improved.

Tender prices continued to rise between April and June, but are not showing the steep increases of the previous two quarters. The provisional index for the second quarter is 351, which is at the bottom end of our forecast range. This represents a 1% rise on the first quarter and a 5.7% rise on the same quarter a year ago. Over the past two years, prices in Greater London have risen 12.5%, and they have increased by 34% since the second quarter of 1996. Over the same four-year period, retail prices have risen just 11.5% and the building cost index by 16%. Despite a slight hiccup in 1996, annual tender price increases have outstripped both retail price and building cost rises every year since 1993.

GDP and output forecasts

Chancellor Gordon Brown and the Monetary Policy Committee have so far succeeded in moderating the UK’s traditional boom-and-slump economy. The Treasury has forecast 2.75-3.25% growth in GDP this year, followed by further growth of 2.25-2.75% in 2001. Most City and independent forecasters concur with these figures. The pattern of GDP growth is expected to be followed by increased demand for construction services.

In 1999, GDP grew by 2.1%. Construction output excluding infrastructure (at constant prices) grew by 1.1%, the lowest annual rate of growth for four years. Since 1996, GDP growth has averaged 2.6% a year, while construction growth, again excluding infrastructure, has averaged 2.2% a year. However, the growth in new work output has been much sharper. Last year, this sector, excluding infrastructure, grew by 5%, and growth in each of the past three years has averaged 5.6%.

Construction Forecasting and Research predicts that total construction output will rise by 2.5% this year and by 2.1% in 2001. But new work activity, excluding infrastructure, is expected to rise just 1.4% this year, with no further growth in 2001.

Construction firms involved in new-build activity will still have to resource an extra £500m of work this year to meet these figures and will have to compete for those resources with firms servicing the repair and maintenance sector, which is undertaking an additional £1bn of work.

Cost drivers

Tender price rises continue to be largely driven by labour costs, although margins throughout the supply chain have improved. The Construction Confederation’s Construction Trends Survey for the first quarter of 2000 found that the labour market had eased marginally, but there continued to be shortages of carpenters, joiners, bricklayers and plasterers, particularly in London, the Midlands, South-west and South-east.

The Federation of Master Builders’ April 2000 survey noted a sharp increase in labour market problems. Nationally, 70% of member firms reported difficulties in obtaining sufficient supplies of skilled labour.

In London, carpenters now command a typical rate of £110 a day, up from £85-90 this time last year. Four years ago, the typical rate was £60-65. Formwork carpenters in London can command £135 a day, compared with £100 18 months ago.

Profit margins

In the last financial year, the top 12 contractors’ margins averaged 2.2%, up slightly from the previous year’s 2%. However, improvements in profit margins appear to be coming more from partnering arrangements, other negotiated work and private finance initiative contracts, rather than traditional contracts. Two-stage tendering is currently one of the most favoured procurement routes and is certainly approved of by subcontractors that, during subsequent tendering of their own work, know that a main contractor has been appointed and that their bid success rate must be much higher. However, main contractors are still offering very low profit percentage mark-ups (for example, 0.75-1%) on subcontract work.


Output growth continued in the first quarter of 2000, according to the DETR. It found that total work in the first quarter was up 4% on last year’s quarterly average (after seasonal adjustment). New work excluding infrastructure was up 6.4%. The strongest growth was in housing, with public sector housing up 28% and private housing up 11% on the quarterly average for 1999. Private commercial work rose 8%. Of course, this additional volume of work was accompanied by a rise in the number of people employed in the industry. It is a result of this increase in workload that labour rates have continued to rise, with the increased housing activity boosting demand for bricklayers and carpenters in particular.

Value of new orders

DETR statistics show that the value of new orders in 1999 was actually 9% down on the previous year. Figures for the first four months of 2000 have maintained the downward trend and represent a 1% drop on 1999.

This decline seems at odds with the output statistics, the two series continuing to move in opposite directions. The Chartered Institute of Purchasing & Supply’s total construction activity index supports the DETR’s output trend. In May, the index recorded its 16th consecutive month of expansion in construction activity and its orders index also recorded a rise in new orders.

Tender price forecast

Tender prices are forecast to rise, as is output, despite the DETR’s somewhat worrying new orders figures. There is some suggestion that the housing market may have peaked for the moment, which could ease pressure on certain craft rates, but demographic figures for the South-east in particular suggest that housing will move ahead once more. Given a continuing increase in overall construction activity, tender prices are forecast to rise 4-6% over the next 12 months, with the highest inflation expected in East Anglia and the South-west. During 2001, as long as health and education spending promises are kept, demand for construction services will see prices rise by a further 4-5%.

Building cost index

The building cost index rose 8.8% in the year to the second quarter of 2000. This was largely because of the wage award that came into effect at the end of June 1999. It was the third part of the three-year agreement adopted in July 1997 that increased basic rates of pay for craft operatives by 10% and general operatives and skill rates by 7.5%. Last August, a new holiday pay scheme came into effect to take into account the legal obligations established by the European Working Time Directive. Together with the additional public holiday for the millennium, the all-in cost of employing a craft operative rose by almost 15% between June and September 1999. A three-year wage agreement has been negotiated that fixes pay rates for building and civil engineering operatives until the end of June 2003 The first part increased basic rates for all grades by 5%. By July 2002, the craft rate will have risen to £7.30 an hour, an increase of 21% on the £6.05 hourly rate in May this year. The agreement provides for uniform percentage increases across the grades, of 5% in 2000, 5.5% in 2001 and 9% in 2002. Materials prices, as measured by the Office for National Statistics, rose 1.6% in the year to April 2000. This is the highest year-on-year percentage rise since January 1998, as the strong pound and low raw materials costs have helped manufacturers hold prices steady. May saw the largest monthly increase in raw materials costs since records began in 1986. Prices for fuel and raw materials rose 3.6% and are 12.9% up over the year. This leap has been largely caused by rising crude oil prices, which are double the level of a year ago. The fall in the pound – sterling has lost 7% in the trade weighted index since May – has pushed up the cost of all imported materials. These factors, coupled with the rise in labour costs, are forecast to push up the building cost index by 3.5% over the next year and by 4.4% in the year to the second quarter of 2002.

Mechanical and electrical cost trends

The mechanical cost index rose 4.4% in the year to the second quarter of 2000, while the electrical cost index increased by 5.8%. Heating and ventilating installation materials costs rose 1.4% in the year to May, according to DETR statistics, but electrical installation materials fell 0.4% over this period. However, the decline in the value of the pound is likely to see some upward price movement in the coming months as commodities such as copper and plastics show higher prices and imported equipment, such as air-conditioning units and luminaires, suffer from the exchange rate dip. M&E workload seems quite varied around the country, with competitive prices being received in some areas but difficult tendering conditions in others. The lift market is certainly busy, with the major manufacturers producing at close to capacity. Expansion is a problem, however, with shortages of experienced lift engineers and skilled labour already being reported. Prices are likely to rise by at least 5% over the next 12 months.

Development cycles 1970-2000

Construction prices have been rising steadily since 1993, yet there is little evidence of the rampant building tender price inflation seen in previous upturns because the industry is not being overstretched by excessive speculative development. The last complete development cycle started in 1982, peaked in 1989 and bottomed out in 1993. There seems to be a long building cycle, averaging nine to 11 years, linked to the production and renewal of buildings (that is, new work, refurbishment and maintenance). The building cycle is also affected by short peaks in demand that typically range from three to five years and are associated with the business cycle. In statistical terms, 35 years is not a long period over which to analyse how the building and demand cycles relate to each other. However, there is a correlation, with high levels of property development in the early 1970s and late 1980s coinciding with boom conditions in the industry. On both occasions, this created significant shortages on the supply side of the construction industry, which culminated in hikes in tender prices. These conditions have not repeated themselves in the current cycle. As far as building tender price inflation in London and the South-east is concerned, the annual average rate of increase over the past 30 years has been 7.5%. Over the past 15 years, the annual average dropped to 3.3%, with the boom that ended in 1989 being followed by the recession of the early 1990s, when tender prices dropped by a third. The impact of the recession can be seen from the average annual increase over the past 10 years of only 1.4%. Since 1995, tender price inflation has averaged 6.1%, and the upward trend continued with a 7% increase in the year to the first quarter of 2000. The good news is that the slowdown in the demand cycle should lead to tender price inflation easing back to about 5% a year over the next two years. Analysis of employment and output data provides an indication of the balance between supply and demand in the industry. The total number of construction workers hit a six-year high of 1.427 million in 1998 and, according to provisional data, is rising again following a fall during 1999. Similarly, output rose to a 10-year high of £51bn in 1999. This figure still falls short of 1989’s all-time high for output – £54bn. The early 1970s and late 1980s booms arose from the combined effect of the building and demand cycles. To understand demand cycles better, it is useful to analyse GDP and new orders over the past 30 years. Peaks in GDP occurred in 1973, 1979 and 1990. The low point was reached in 1994. Since then, the recovery has been under way and is forecast to continue to 2001 and beyond. Historically, changes in construction output trends tend to occur one year before a similar change to GDP. New orders are the best measure of demand trends arising from the business cycle. The peaks in new orders over the past 30 years were in 1972, 1976, 1978, 1984, 1988, 1994 and 1998. So, since the early 1970s, the short-term demand cycle has lasted between two and six years, with the major peaks in 1972, 1978 and 1988. In each case, the year before the high points for output proved to be significant. From this evidence, there is a clear relationship between new orders and output and a similar relationship between output and GDP. New orders figures reached a nine-year high of £20bn in 1998. Although the demand cycle for some sectors has now reversed, increases in housing (particularly in the South-east), education and private finance initiative health work should re-establish the upward trend in orders by the end of the year. Thus the demand cycle will build once more towards its next peak around the beginning of 2002. In summary, the current building cycle has been extended by a combination of a steady economy, multiple sources of workload and an absence of boom-and-bust conditions in the industry itself. Although the end of the current upswing is likely to occur within the next two years, the relatively steady conditions now being experienced suggest that the inevitable downturn will be less severe than in 1990-1993.