The construction industry appears to be in a decline similar to that of the last UK financial recession. According to the Purchasing Managers Index (PMI) and IHS Markit, June, July and August 2019 recorded the lowest activity levels since April 2009 when the recession was at its height. Meanwhile, the CITB/Experian forecasts predict that there will be a small 3% growth in UK construction output next year, followed by 1% growth in 2021 and 2022, before slowing to zero growth in 2023. Brexit uncertainty, and worries about a general election, continue to drive expectations of a sharp construction decline, especially in the commercial sector. So how are construction companies fairing in this rollercoaster of a market?
Not so well is the simple answer. A day barely passes without the news of another organisation going into administration, seeking refinancing or issuing a profit warning.
But rollercoaster markets are nothing new in an industry renowned for its boom and bust cycles. So why does this turbulence cause such catastrophic failures? It appears that contractors still haven’t learnt or developed the resilience needed to weather downturns in the market. It could be expected that a few companies would fail in hard times, but the sheer numbers of those in difficulty suggests that there is something fundamentally wrong with the industry. Change is necessary to stop this cycle and prevent the company failures that have become commonplace and which have such a devastating impact on employees, the supply chain and all stakeholders.
Insight can be gained from the Government’s investigation into the collapse of Carillion. It suggests that problems were initially caused by aggressive bidding and then covered up by aggressive accounting. The company won too many risky projects at too low a profit margin. Then problems on these projects were funded by ever increasing debt and masked by overly optimistic accounting (declaring revenue and profits based on optimistic forecasts, before the money has actually been made). Eventually, the inevitable happened when Carillion had to write down the value of these projects which amounted to a £845m charge. This wiped £1.2bn from the company’s value. To make matters worse, whilst these problems were developing in the five-and-half-year period from January 2012 to June 2017, Carillion paid out £333 million more in dividends than it generated in cash from its operations.
Was Carillion a one-off in the industry? No, many construction companies survive by keeping cash flowing through the business. In order to do this, they must secure work. In a competitive market they will bid lower than their competitors and take on more risk hoping that they claw some extra money out of the contract at a later date. High risk and low price is often a fatal combination for contractors. In the past, when interest rates were higher, contractors could make money from the interest they gained on the cash passing through their business. They could hold onto their payments and pay suppliers and sub-contractors later once they had accrued interest. This is simply not possible today. Interest rates are low, risks materialise, and project variations are more often the contractors risk leaving no room to eek extra monies out of a project. When things go wrong often there simply isn’t enough money to recover the situation. The losses are often masked in the short-term in the hope that good times are just around the corner and the company can recover in the long-term.
It could be said that competitive bidding on price alone is toxic to the construction industry. It simply encourages companies that are in financial difficulty to bid lower than others to secure money through the business. Added to this there is often a period of beating down a winning contractor to an even lower price. Ultimately this can put the nail in the coffin of the winning bidder, leave Clients with the nightmare of half completed projects, leave sub-contractors and suppliers without payment all in the name of getting the most competitive price.
For competition to be fought fairly on price, construction would need to operate as a ‘commodity market’. Every company would offer the same product, service and solution. Is this the case in construction? Does every contractor offer the same service or product? No, each contractor has a different culture, skills, processes and approach. These are represented in the company’s brand and realised through their strategy. It is these which differentiate the contractor from its competitors. So why, when it comes to winning work, is competition often fought on lowest price rather than on differentiation?
As an engineering-based industry, construction is bursting with superb logical problem solvers who are working hard to solve the Client’s problems. Every work winning team in every competing contractor will do their utmost to come up with the best operational way of working for each individual project in order to deliver the best for the Client and to keep costs down. The issue with this is that the focus can shift away from the company’s unique brand and strategy. A differentiated competitive strategy is then lost and it’s back to competing on price.
To end the cycle of boom and bust and build more sustainable models for delivering projects, which will ultimately benefit all stakeholders, need to be utilised. Alternatives include alliancing or partnering where all parties, including the Client, work together and share equally in the decision making, risks and rewards. In order to achieve this shift towards collaboration based on best fit between companies’ values, vision etc. and away from lowest price wins, construction leaders need to drive the change and show strong strategic leadership.
We know that good operational leaders often get promoted into strategic leadership positions, but have they developed the strategic thinking ability to do well in the role? The problem is that our thinking processes determine what we perceive. If we can’t think strategically, we won’t see strategic problems. Instead, we continue to see and solve operational problems. There is a saying that if all you have in your toolbox is a hammer then everything looks like a nail. It is likely that many ‘strategic leaders’ in the industry are unaware that they are continuing to lead from an operational perspective.
Until greater strategic thinking ability is developed throughout the construction industry, competition in work winning will continue to be fought primarily on price. This leaves contractors increasingly likely to take risks they are unable to mitigate. As a result, companies won’t develop the resilience they need to survive and thrive in this most turbulent and exciting market.