Construction costs are soaring.
Aecom’s latest London Contractors’ Survey put inflation at ten per cent during 2015, and is predicting increases of at least seven per cent in 2016.
And that was before a potential Brexit came into play.
So why are prices rising and what, if anything, can employers do about it?
The principal reason for price increases is a lack of supply in the market, resulting in the high growth rate of wages within the industry.
The growth rate of material costs is still moderate so combine these factors with an increase in opportunities and many employers would be forgiven for thinking that GMP actually stands for Guaranteed Minimum Price!
”The principal reason for price increases is a lack of supply in the market”
The effect of a Brexit could be significant, not least because the UK construction sector is heavily reliant on skilled immigrant labour, much of which comes from within the EU.
A stretched market
It’s hard to envisage that a climate of uncertainty – likely to prevail while trade deals are being negotiated – would not exacerbate the issue of rising costs.
Constrained by a growing skills shortage, contractors are increasingly keen to bid for repeat and higher margin work that enables them to maintain and increase profitability.
The increased demand for skilled labour means that contractors are stretched and employers are not always going to receive the A team.
Contractors can afford to be choosy about which projects they tender and many are refusing to submit tenders on up to 50 per cent of projects offered to them, with some main contractors only considering 25 per cent of opportunities.
With a potentially weaker delivery team, and a price that is not market tested to any great degree, employers can no longer be sure that they are getting the value they were accustomed in previous years. In fact, they can probably be sure of the opposite.
”The increased demand for skilled labour means that contractors are stretched”
Add to this the fact that tender prices are increasing not only due to rising labour costs but also due to an expectation of increased margin and a risk price that reflects the ever-present risk of insolvency.
This backdrop has seen the death of single-stage tendering, with contractors refusing to commit to a price until a much later stage and when they do, it is often at a premium.
A perfect storm
All of this means the market is in the perfect storm, with contractors focusing on higher margin work and lower risk projects, and employers juggling the need to attract quality contractors with cost control.
But there are measures employers can use to get around these hurdles.
Fast tracking the project, for example, by procuring early works packages with specialist contractors ahead of engaging the main contractor on site, saving further inflation and overhead and profit on these works.
The braver employer may even go the whole hog with construction management instead. And we are seeing lenders accept this procurement method more readily these days.
Also, avoid variations, as last minute changes of mind will increase costs and bring inflation back into play. However this can be easier said than done if considerable value engineering took place to meet the budget.
Lastly, employers should consider incorporating shared savings mechanisms, where the contractor also benefits from any price reductions that can be achieved. Without these, there is little real incentive on the contractor to generate cost savings for the employer.
Beyond that, perhaps just wait for the next cycle…
Stephen Malley is the UK Head of Construction at DLA Piper UK