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Construction Inflation

UK Construction Intelligence Report

In this time of rapidly increasing volatility in costs and the availability and pricing of labour and materials, contractors have become more risk averse and are looking to pass the risk onto Clients. How can both parties reduce the risk they are exposed to?

Although we anticipate that the normal supply chain will be resolved in 2022, until then this potentially this will have a major effect on project timescales and delivery costs. Spiralling cost inflation coupled with a fixed price environment will eat into the margins of contractors and suppliers causing instability and possibly more firms going insolvent.

With the market buoyant finding tenderers is becoming harder with many contractors and sub-contractors having near full order books or unwilling to commit to tendering for projects in 6 months’ time as they are getting more selective.

With the current instability being experienced in material costs, contractors are reducing the period that they will hold fixed price tenders for. In certain markets sub-contractors such as steelwork and cladding sub-contractors are in a strong position to force the main contractor’s hand by only committing to hold prices for a short period.

These factors have contributed to PQQ’s and tendering periods increasing together with a change in the preferred procurement route.

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The use of single stage procurement route grew during 2020 and early 2021 and provides the chance to secure fixed rates. However, contractors are increasing less interested in this procurement route and including inflated rates as insurance for future cost increases.

This has seen the re-emergence of 2 stage tenders, bringing the contractor on board earlier. The drawback is the risk of experiencing large increases on packages during the second stage as contractors return with prices from their supply chains.

Material unavailability is a major concern and could cause project completions to be delayed. To limit the effects of delays efficient planning will be essential to alleviate delays. Parties should determine what could be pre-ordered / pre-purchased. Early placement of orders could be undertaken during 2 stage negotiations together with the possibility of obtaining the materials from a variety of sources. On projects where the completion date isn’t essential the use of allowing extensions of time for delays caused by material delays should be considered.

All parties need to work together to reduce risk and with it a reduction in costs. Options include the use of hybrid of Guaranteed Maximum Price where a sliding scale of rewards for savings can be used on these items and either the contractor retains all the sum or return some of the saving.

The Construction Leadership Council (CLC) have suggested to combat inflation one solution is the adoption of using fluctuations clauses as a way of sharing the risks associated with this volatility, a solution commonly seen in the 1970’s but rarely since.

This has several drawbacks with Funders preferring a fixed price before commencement to ensure viability. Fluctuation clauses will mean cost uncertainty for the Client, especially faced with trades that are not on site for another 12 – 18 months. Application of the clauses will mean extra work for the auditing of the application of indices and potential additional fees.

TPI Predictions

In the 1st Quarter Construction Intelligence Report we noted that for the construction industry to thrive it needed the wider economy to be recovering and for economic factors to be conductive for this to occur. Since the last report the threat of a double dip recession passed without realisation and the economy is forecast to enjoy steady growth in the next few years.

It looks probable that we will be living with Covid for the next few years. While the Site Operating Procedures (SOP) is now defunct, many contractors and consultants have retained amended procedures with productivity at a similar level to pre-pandemic and with these additional overhead costs are a factor to consider.

There are many positives, the GDP forecast is above that previous predicted, presently the forecast for unemployment is far lower than anticipated. Confidence rates are high and construction output is only just below the pre-pandemic levels.

The ONS has reported good new orders for 2021 and the pipeline for 2022 looks solid driven by the large infrastructure projects and housing projects. While some sectors have remained deflated, such as commercial and retail, contractors have sought to diversify the sectors in which they work.

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The recovery has brought with it the demise of contractors and suppliers who were unable to remain solvent through the last 18 months and with-it less competition and capacity. Those who have survived will be looking for a way to ensure increased turnover and recover lost income.

With the market still growing contractors can be selective with the projects they tender for, the risks they will take on and how they pass on the costs. The need to cover themselves against material cost increases can be seen in the increasing tender prices and the move to 2 stage tenders.

Currently the main problems are increased material costs, extended lead in times for obtaining materials and labour shortages. We anticipate that the shortage of material supplies should be resolved in the 1st half of 2022, this should lead to a more stable environment without seeing a glut of material increases and lead in times for materials should decrease.

Currently labour is presently an obstacle to output, but the UK faces a longer-term problem with labour supply, and with it the threat of decreased output and increased wages. The move to increasing off site construction will assist this but the UK lags far behind mainland Europe and training an enlarged workforce will take time to overcome this quandary.

These have led to inflationary pressures, which could steer the path of government expenditure. The current ambitious spending programme is dependent on being able to borrow at today's record low interest rates. The threat of inflation could mean banks increasing interest rates with the knock on of increasing unemployment, lower consumer spending and less tax revenue. In turn this could reduce government and private investment, leading to competitive tenders undertaken by a supply chain already working on small margins.

During the first half of 2021 material and labour cost increases were absorbed in tenders, this has changed as contractors are not prepared to stand the cost and have begun to pass costs on. Tied in with this the sector needs to return to sustainable levels of turnover and profitability and we should expect tender levels to increase steadily in the next few years.

Trends

As always, the procurement route, tendering strategy and contractor selection continue to have a significant influence on levels of price inflation. Each project needs to be assessed individually and the forecast is based on an average across the commercial property sector.

Faithful+Gould also provide global indices for major cities around the world based on input from our worldwide network of offices and publicly available material. Click on the link 2020 Global Location Indices.