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If we are to determine how major British construction contractors will respond to Brexit, we need to understand their past. Whilst it is good to learn from the past, if it is held on to too tightly, there is a danger it creates a mindset with constrains our future.  Do major British contractors have a mindset which will constrain their post Brexit future?

 

Early Days 

 

Many British major contractors were established as family owned businesses in the second half of the 19th Century, however, it was the Second World War which led to them becoming major players. During the rearmament, war and reconstruction periods, construction contractors had growing workloads dominated by the government as client.  The government concentrated the work in the hands of a few contractors which had good reputations, national coverage, new management capabilities, and resources, such as Laing, Wimpey, Sir Robert McAlpine and Costain. In the 1950’s, through being too dependent on government work, these contractors then suffered from the ‘boom and bust cycle’ and, as a result, diversified into house building as a way of smoothing out workload and spreading the risk. They also experienced low productivity and low profit margins.  However, interest rates were reasonably high.  It was during the 1950s that the major contractors started to move away from ‘self-delivery’ and increased their use of subcontractors in order to spread the risk. This move to the use of subcontractors was accelerated in the 1960s and 1970s in response to difficulties with industrial relations.  The use of subcontractors also allowed the contractors to invest the working capital gained in the time they were paid and the time they paid subcontractors. The business model of the major contractors then changed from focusing on profit margin to managing cash and increasing ‘Return on Capital Employed’ (ROCE).

 

1960s - 1970s

 

The increased working capital helped to fund expansion into international markets. Costain led the way in the 1950s with others soon to follow. By 1968, construction became the fastest growing export industry with overseas earnings trebling in size since 1955. With the different overseas markets off-setting each other, most large British contractors sustained a reasonable level of profitability overall.  However, the low productivity and tight margins continued to make managers cautious and defensive when it came to investments.  The senior leaders in the industry had developed, what Professor Hedley Smyth (The Bartlett School of Construction and Project Management, UCL) has termed, a ‘survival mentality’. This was a hang-over from their experience of the boom and bust markets of the 1950s. As a result, senior managers reacted to market trends rather than anticipating, creating or influencing them.  As the international markets grew in the 1970s, off the back of Middle East oil revenues, the survival mentality meant that major British contractors followed the work around rather than investing in and establishing long-term regional businesses overseas. 

 

1980s -1990s

 

By the 1980s, most of the major contractors had separated ownership and management by floating on the stock exchange. Now, due to stock market pressure, finance was dominating board room decision making. This was characterised by short-term transactional thinking designed to maximise ROCE which, in turn, constrained long-term investment.  The focus was on financial risk management rather than on developing capability to serve clients and develop long-term businesses.  The survival mentally, combining with a short-term focus on financial performance, meant that British major contractors concentrated on divestment through into the 1990s.  For many contractors this included withdrawing from their overseas operations due to loss making projects. During the recession between 1993-1996 British major contractors lost 18% of their market share to their European counterparts such as Hochtief and Skanska (Smyth - 1998). In the 1960s the British major contractors were amongst the leaders internationally.  By 1996, only AMEC was in the top 10 on a European scale. The question must be asked, why were European contractors able to succeed in markets where the UK major contractors were failing?

 

It could be argued that it was the overreliance on ROCE, lack of improvements in productivity and short-term survivalist thinking which were at the core of the decline of the British major contractor. 

 

2000s

 

During the 2000s, despite the work done by Latham and Egan, the major British contractors struggled to increase productivity.  They continued to lose market share to the European contractors now entering the UK.  The love affair with ROCE came to a dramatic end with the financial collapse in 2008 and the reduction in interest rates in its aftermath. 

 

2010 - Present

 

Since the financial crisis, most major British contractors have struggled to recover. We have already seen Carilion collapse and Interserve continue to operate in administration under a Pre-Pack Arrangement. Only a few major contractors continue to operate overseas in some form, most notably Laing O’Rourke and Balfour Beatty.  According to ENR (Engineering News Record) the top 5 international contractors are now all from China with few European contractors are in the top 20, such as Vinci (6th), ACS (7th), Bouygues (10th), Hochtief (11th), Strabag (13th) and Skanska (16th).  The British major construction contractor, the likes of what we saw in the 1960s, is not to be seen in ENR’s top 20.

 

With the divestment from housing and the withdrawal from overseas markets, many of the British major construction contractors are now operating with little diversification.  They are, once again, overly exposed to the ‘boom and bust’ nature of UK market.  Lack of increases in productivity continue to result in low profit margins, whilst low interest rates and a push to pay subcontractors on time are eroding ROCE. The survival mentality with a focus on short-term financial performance has not left the British major contractor well positioned to take on the challenges of Brexit.

 

Post Brexit Future

 

Post Brexit the government may use the investments in the construction of infrastructure to boost the economy.  However, the indecision over major infrastructure projects such as the Heathrow expansion and HS2 puts in some doubt as how much of this investment will actually materialise as construction projects. Inevitably, the UK will have to weather the funding cuts in major infrastructure projects which were once secured from the European Investment Bank and European Investment Fund.  Reduced confidence in the UK economy may also result in a decrease in demand for projects from the private sector.  For projects which do go ahead, they may suffer from labour shortages and increases in the cost of materials.  The degree to which these threats materialise, depends on the nature of a trade agreement that is negotiated with the EU. Whatever happens post Brexit, it is likely that the UK construction market will continue to be boom and bust leaving the undiversified contractor woefully exposed.

 

So, where could a prosperous post Brexit future lie for the British major construction contractor?

 

In 2017 the Government said by 2030 global annual construction investment is expected to grow by 85% to $15.5 trillion. In a bid to help British firms win major construction contracts overseas, the UK government then launched a new body, called Infrastructure Exports: UK (IE:UK), which will organise British consortiums to win a slice of this work. To secure international work, the British contractor would need to demonstrate they have something, needed by the project, which local firms are unable to deliver. Do British contractors still bring this added value? Could the British major contractor once again become a leading player on the global stage?  Could British major contractors take on international projects without risking serious loses?

 

If the British major contractor is to once again diversify overseas successfully, this will require the senior leaders in the industry to invest to create long-term regional businesses, increase productivity, and develop the capability of their people.   The willingness to invest will follow a move away from the ‘survival mentality’, which has plagued the industry for decades, and the short-term financial thinking in the board room. 

 

Eleftherios (Lefty) Panayiotou

Director | Management Consultant

30th January 2020

 

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