“Profit is not a dirty word, a contractor’s profit should be a reflection of the premium of the risk on the job.”
These were the words of a construction industry veteran I was speaking to recently.
If you’re doing a complex job you should build in a bigger margin to protect against unforeseen problems, and vice versa for a simpler job.
So, with the industry’s recent high-profile woes, are contractors misjudging the level of risk on some jobs? Or are they failing to price it in?
Either way, since Carillion’s collapse, the persistent murmurs about the need for higher margins have grown louder, with some tier ones targeting 5 per cent or more.
Speaking to Balfour Beatty chief executive Leo Quinn yesterday, following the company’s annual results, he said the industry needed “leadership and resistance” to avoid getting into bidding wars and work being awarded on lowest price.
Aside from contractors showing a little solidarity, Mr Quinn thinks clients have a big role to play in bringing “sensible sharing of risk and sensible margins” back to the industry.
Laing O’Rourke group finance director Stewart McIntyre told me that risk between client and contractor was “skewed the wrong way”, but he placed more blame on other contractors. Some firms, he said, have driven down margins to win work in order to keep turnover growing and order books fat.
While you can point fingers at the attitudes of clients or contractors for low margins, there’s a good argument that they are a product of the fragmented nature of the industry.
Kier boss Haydn Mursell cited this as the reason as to why it’s so hard to secure bigger margins in the UK when I spoke to him this morning.
According to Mr Mursell, Kier is the biggest contractor by value of work in the UK infrastructure services and building market, but it still only accounts for 3-4 per cent of the total.
With so many competitors, it’s hard to create a unified front to show resistance to lowest-price bidding and unfair terms on risk.
There are signs that change is in the air, though.
The Cabinet Office has expressed interest in procuring on more qualitative terms rather than being so price driven, according to Mr Mursell.
He also said that the largest contractors like Balfour and Kier would not touch big, fixed-price jobs like the Lower Thames Crossing anymore, seeking more of a partnership agreement, as seen on Crossrail, with client and contractor agreeing to share the gain or the pain on the final account.
But it’s easier to turn your back on work in (relatively) buoyant times.
Construction is highly cyclical, and as Mr Mursell pointed out, the allocation of risk changes depending on whether the industry is up or down.
If times get tougher and more power flows to the clients, it stands to reason that any “resistance” to accepting more risk and low margins will collapse in such a fragmented market.
So unless we see significant consolidation of the market, or the elimination of economic cycles, higher margins are unlikely to materialise any time soon.