Fresh round of cost-cutting essential, contractors told

Contractors will need to undertake far more extensive cost cutting reductions to offset an acute reduction in work in the coming years, a report by KPMG has warned.

The analysis of development margins across 14 of the UK’s largest contractors warned of an urgent need for further cost efficiency and restructuring across the construction sector.

KPMG’s Construction Barometer found that, contrary to popular perception, the UK construction industry battled the recession relatively successfully during the first three years and only succumbed to sustained margin erosion from 2010 onwards.

The report said that between 2007 and 2010 construction margins were actually on the rise, offsetting tightening margins in other activities, such as support services and house building.

The analysis found this could be due to construction divisions successfully removing cost faster than revenues were falling, as well as the impact of the lag between contract tender and profit realisation.

The real crunch came in 2010 when most of the remaining contracts bid pre-recession reached completion, the report said.

Richard Threlfall, KPMG’s head of infrastructure, building and construction said: “Our analysis reveals that the industry did well to anticipate the downturn and take out cost in the early years of recession, even managing to drive up margins in the short term.

“However, those measures are now proving insufficient to offset the acute reduction in volumes of new work. Just a quick look at the development of margins in the last two years confirms the urgent need for further cost efficiency and restructuring across the industry.

“Unless action is taken now the thin margins of 2007 will seem generous by comparison to what the industry may be facing.”

“Since 2010 there has been a scramble in the industry to stem the collapse of forward order books, underpinned by deliberate profit-sacrifice.

“This has resulted in a steady fall in the average construction margin, with early indications being that 2012 results are not likely to buck this trend.”

Other key trends revealed by the analysis:

• Ownership structure: Listed entities appear to have focussed on maintaining or growing revenue, which has translated well for group margins but offers a more mixed picture for construction margins. Private and foreign owned businesses have shown a clearer inverse correlation between revenue and margin growth, suggesting a strategy of sacrificing revenue in the pursuit of superior margins may be being successfully employed here.
• Reliance on construction activity: Diversified companies, where construction segment revenues account for less than two thirds of the total business, have seen the most consistent revenue and margin growth.
• Size of business: In general larger companies have more consistently shown growth, particularly in revenue terms.

Threlfall said: “On the whole the UK’s main contractors appear to be standing firm. Businesses that succeeded in re-organizing themselves have been credited with steadying their operating margins as they emerge.

“Getting the right client mix has also been credited with helping protect margins and pipeline, as has involvement in large-scale infrastructure projects. What is marked is the variety of strategies adopted and levels of success with which these appear to have been implemented.”

KPMG’s Construction Barometer is available here.